Question

In: Economics

1. What are the political and economic limitations upon (a) fiscal policy and (b) monetary policy?...

1. What are the political and economic limitations upon (a) fiscal policy and (b) monetary policy? One of the advantages of monetary policy is its speed and flexibility, but there are limitations. Explain.

2. One of the advantages of monetary policy is its speed and flexibility, but there are limitations. Explain.

Solutions

Expert Solution

Tools of fiscal policy like budget, taxation, public spending and debt have great practical limitations and give rise to certain fundamental problems.

These difficulties are mainly three. The effectiveness of fiscal policy depends on the size of the measures adopted and their timing.

There are political and administrative delays in taking action, particularly when legislative sanctions are required to change the rates and composition of taxes or program spending. As a consequence of these policies, the achievement of fiscal policies also relies on the redistribution of revenue and a chain of people's financial and psychological responses.

Again, the impacts of an rise in government spending are counteracted to some extent by an rise in import value and a decrease in export value, thereby decreasing the impacts of multipliers. In addition, funds for enhanced spending should be raised in such a manner that investment in private-sector sectors would not be depressed. The latter would suffer forever if a public demand for labor and raw materials compete with private sectors.

Government spending should therefore be such as to complement personal investment rather than supplant it. Additionally, government spending may not be in the direction of correcting depression-induced maladjustments and may even be neutralized by variables operating in the opposite direction, such as structural unemployment.

It is necessary to use the entire fiscal armory with excellent care. Thus, by choosing policy lags and timing coupled with recognition, action, administrative, operational lags, the efficacy of fiscal policy is significantly impaired. In addition, there is the issue of fiscal measures forecasting, selectivity and adequacy. The different offsetting fiscal policies sometimes become mutually offsetting. It is necessary to adopt safeguards against these constraints.

The weaknesses of monetary policy made fiscal policy a powerful weapon for checking unemployment and depression. In case of worst depressions, fiscal policy can be resorted to through public works expenditures.

Fiscal policy weakness lies in the difficulty of implementing adequate restraint in moments of inflation. Monetary and fiscal policy limitations obviously warn us not to assume that we have strongly in hand the issues of stable economic growth and full employment.


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