Question

What are the major problems of the fiscal policy? How does fiscal policy differ from the monetary policy in the USA economic system?

Answer 1

There is not much arguing over the desirability or otherwise of a discretionary fiscal policy in recent times. In this context the burning question is related to the timing of the fiscal measures. The desired countercyclical effects can not be achieved unless the fluctuations in taxes and public expenditure are conveniently coordinated. There is usually some gap between the period when a specific action is required and the time when the effect of a fiscal measure is felt. The length of this period defines how effective a particular fiscal measure can be. This time span contains three forms of error-recognition lag, administrative lag and operational lag.

Recognition Lag: This is the interval between when action is required and when action is remembered. This lag can occur when an economic change does not align with a study on the change. A lag like this has a duration of 3 months. If the forecasting is satisfactory it can be reduced.

Administrative Lag: This is the interval between the awareness of the need for an action and the moment when the action is actually being taken. That may be the toughest lag to contend with. Even when the need for action has been recognised, it must take some time to approve the legislature and executive and that may take between 1 to 15 months.

Monetary policy is about raising the rate of interest and controlling the money supply.
Fiscal policy involves the government adjusting tax rates and government spending levels to affect overall economic demand. Monetary policy is set by the Central Bank, thereby minimizing political influence (e.g. policymakers may cut interest rates in the effort to have a booming economy before a general election) Fiscal policy may have more supply side effects on the wider economy. For example, rising inflation–higher taxes and lower spending would not be common and the government might be hesitant to undertake this.

Monetarists claim that expansionary fiscal policy (larger budget deficit) is likely to cause crowding out–higher government spending cuts private-sector investment, and higher government borrowing drives interest rates up. (This interpretation is contested, however) Expansionary fiscal policy (e.g. further government spending) may lead to special interest groups lobbying for investment that is not really helpful