Question

Assume reports are showing the economy is slowing and its evident that the economy has entered the contractionary phase of the business cycle.  Suppose its decided to enact fiscal policy to return the economy back to a healthy state.

a) Discuss the tools available to achieve that endeavor and how they work to strengthen the economy.

b) Briefly discuss the long lags associated with fiscal policy that do not exist with monetary policy.

Answer 1

A - There are mainly two fiscal tools available for take the economy out of contractionary phase. These are -

1 - Increase in government spending - This tool will help to increase the output in the economy through greater investment. The employment rates will rise , income will increase and hence AD will also increase.

2 - Decrease in Taxes - The decrease in the level of taxes will increase the real disposable income of the public. They will increase their consumption which is a part of AD. The value of AD will increase and the economy will be out of contractionary phase.

B - There are huge implementation lag in the fiscal policies , which in moentary policy is unlikely. In the case of fiscal policy , the policy related to the tool as to passed at several levels , in the parliament , with the president. After all these approvals , it comes into reality. All these implementation procedures take a huge amount of time resulting in the huge time lags in fiscal policy