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Challenges of Fiscal Policy Evaluation and Application: Timing, Politics, and International Impacts

Discover the difficulties faced by governments in enacting and implementing fiscal policies due to timing lags, political influences, offsetting actions by governments, crowding-out effects, net-export impacts, shocks from abroad, and the implications of supply-side fiscal policies. Explore the reasons why executing effective fiscal policy measures can be a complex and challenging process.

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Challenges of Fiscal Policy Evaluation and Application: Timing, Politics, and International Impacts

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  1. Problems, Criticisms, and Complications Fiscal Policy Evaluations

  2. Why is it so Hard for the Government to Enact and Apply Fiscal Policy

  3. 1) Timing (Lag-time)

  4. Recognition Lag • The time between the beginning of recession or inflation and the awareness that it is actually occurring. • This happens because of the difficulty in predicting the future course of economic activity.

  5. Administrative Lag • The time between the recognition of the need for fiscal action and the time action is taken. • This is a downside of democracy. It might take months or years for policies to work their way through the legislative process.

  6. Operational Lag • It occurs between the time when fiscal action is taken and when the action takes effect on output, employment, or the price level. • Government spending requires long planning periods and even longer periods of construction. • While tax rates can be implemented quickly, people might take time to alter Consumption.

  7. 2. Politics • Politicians want to get re-elected, and often overlook the best economic course for the most politically beneficial course. • The political business cycle emerges, where politicians may cause inappropriate changes in AD and cause economic fluctuations, especially around elections.

  8. 3. Offsetting Governments • At times of recession, provincial governments might increase taxes or impose new taxes to offset lower tax revenues resulting from the reduced personal income and spending of their citizens. • The Federal government might be increasing government spending, but the higher local taxes restrict AD and GDP from expanding.

  9. 4. Crowding-Out Effect • An expansionary fiscal policy may increase the interest rate and reduce spending, thereby weakening or canceling the stimulus of the expansionary policy. • Expansionary fiscal policy involves the government taking loans. Increase in public loans drives up the demand for loans and increases interest rates. • Investment spending and interest rates are inversely related so some investment will be "crowded" out.

  10. 5. Net-Export Effect • An expansionary fiscal policy resulting from a tax cut or an increase in government spending will shift AD right, this raises prices. • Foreigners will demand fewer goods because of the increased price level, which decreases net exports, and shifts AD left. • Expansionary fiscal policy intended to increase C/G/Ig, may be offset by decreased Xn.

  11. 6. Shocks from Abroad / Overseas • Events and policies abroad can shock our economy and cause unforeseen increases or decreases in aggregate demand. • If foreign countries enact spending measures to stimulate their local consumption, our XN might rise and vice versa. • We can be mutually interdependent.

  12. Supply-Side Fiscal Policy: Business & Personal Tax Cuts • Tax changes that affect the aggregate supply curve (AS). • Tax cuts might shift AS right and negate the effect of inflation, while increasing economic growth (GDP) • Savings & Investment • Work Incentives • Risk-Taking

  13. Questions for Exam and Test Review • Page 275. Questions 7, 8, 9, 11, 12.

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