Question

Is Fiscal Policy Dead?

In recent decades many economists and policy makers had generally agreed that the age of using fiscal policy to control the business cycle had ended. Primarily this was because fiscal policy suffers from more time lags and is politically more difficult in the US compared to monetary policy.

During the next contraction, would you recommend using fiscal policy to stimulate the economy or should we rely only on monetary policy tools? Secondly, what laws, rules, etc. could be put into place to ensure that politicians 'undo' the expansionary fiscal policies (that is cut spending and raise taxes) once the need for economic stimulus has passed? (This is necessary so that the economy doesn't experience rapid inflation following a contraction.)

Answer 1

Monetary policy has one advantage over fiscal policy that is it is politically independent . Political influence over fiscal policy increases time lags and sometimes renders it ineffective . Monetary policy tools has comparatively lesser time lag , a cut in interest rate immediately increases demand for loanable funds , thus pulling an economy out of recession .

Expansionary fiscal policy such as tax cuts and spending must be made temporary . Tax cuts must be given for a particular time frame only , after which taxes should be back to original level . Also increase in spending by government should be more sector specific and limited to some extent . This helps to check the over effects of expansionary policies .