Answered: Key limitations to fiscal policies.

Macroeconomics

13th Edition

ISBN:9781337617390

Author:Roger A. Arnold

Publisher:Roger A. Arnold

Chapter11: Fiscal Policy And The Federal Budget

Section: Chapter Questions

Problem 19QP

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Key limitations to fiscal policies.

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Fiscal Policy is that the use of state spending and taxation levels to influence the amount of economic activity. In theory, economic policy will be accustomed prevent inflation and avoid recession.

Following are the limitations of fiscal policy:

Disincentives of Tax Cuts: Increasing taxes to cut back AD may cause disincentives to figure, if this happens, there'll be a fall in productivity and AS could fall. However higher taxes don't necessarily reduce incentives to figure if the income effect dominates the substitution effect.
Side effects on public spending: Reduced government spending (G) to decrease inflationary pressure could adversely affect public services like transport and education causing market failure and social inefficiency.
Poor information. economic policy will suffer if the govt. has poor information. E.g. If the govt. believes there's visiting be a recession, they'll increase AD, however, if this forecast was wrong and also the economy grew too fast, the govt action would cause inflation.
Budget Deficit: Expansionary economic policy (cutting taxes and increasing G) will cause a rise within the deficit which has many adverse effects. a better deficit would force higher taxes within the future and will cause crowding out.
Depends on the Multiplier effect: Any change in injections could also be increased by the multiplier effect, therefore the dimensions of the multiplier are significant. If consumers save any extra income, the multiplier effect are low and monetary policy less effective.
Real trade cycle critique: The real fluctuation argues that macroeconomic fluctuations are thanks to changes in technological progress and supply-side shocks. Therefore, using demand-side policy to influence economic process fails to handle the difficulty and just makes matters worse.

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