Discretionary Fiscal Policy

Discretionary fiscal policy is the deliberate manipulation of taxes and government spending to alter real GDP and employment, control inflation, and stimulate economic growth.

Criticisms and Complications of Fiscal Policy

Timing Problems

• Recognition Lag - it takes time for economists to recognize a recession is occurring

• Administrative Lag - it takes time for the government to act

• Operational Lag - it takes time for the changes to take effect

Crowding Out Effect

This occurs under an expansionary fiscal policy.  If the government enters the money market to finance the deficit, the government will crowd out investors.  The increased demand for money raises interest rates.  Because investment is inversely related to interest rates, investment will decrease.  This will offset the effects of an expansionary fiscal policy - the aggregate demand curve moves slightly to the left.

Net Export Effect

This occurs under an expansionary fiscal policy.  If the government enters the money market to finance the deficit, interest rates will rise.  The higher interest rate causes the dollar to appreciate.  Therefore, net exports decline, and aggregate demand decreases, which offsets the effects of expansionary fiscal policy.

See:

• Expansionary Fiscal Policy

• Contractionary Fiscal Policy

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