Limitations+on+Fiscal+Policy

** LIMITATIONS OF FISCAL POLICY  **

 · ** “Fiscal policy  ** refers to the governments approach toward its own spending and taxation.“ During periods of contraction, the government can help kick start the economy and consumer confidence through spending. This is referred to as the Keynesian School, after the economist John Keynes.  · ** “Countercyclical fiscal policy  ** is deliberate adjustments in the level of government spending and taxation in order to close recessionary or inflationary gaps.”  · ** “Balanced-budget fiscal policy  ** is the belief that a government’s budget should be balance in each budget period. “   First of all varying government spending can be tricky because the government needs to keep voters happy to get reelected. This makes it difficult to raise taxes. It is also difficult to cut government spending because people don’t want their childcare, education, or health care programs to be taken away. A second problem occurs when you take into account the relationship between the different levels of government can sometimes cause difficulties. If the Federal government is focusing on spending to get out of a recessionary phase and the Provincial government is increasing their sales tax at the same time, the effects can cancel each other out. Changes in government spending and taxation are slow to take effect because of lags. There are several types of lags that occur. Problem arises à Recognition lag à Problem Recognized à Decision lag à Decision made à Implementation lag à Decision implemented à Impact lag à Policy Effect  · Recognition lags are the time before a problem is recognized.  · Decision lags is the time between decision to act and implementation.  · Impact lags (effect) is the time between implementation and when economy starts to feel the impact.  · This can take years and in the mean time the economy could fix itself. Criticisms of ** balanced-budget fiscal policy ** worry that action by the government tends to push the economy in the same direction it is leaning in or what is known as procyclical. That is during periods where the economy is experiencing a recessionary gap, and net tax income levels are low the government would run a deficit. Then during periods of growth they would pay it back. However, sometimes the surplus created during an expansionary phase does not equal the deficit accumulated during the recessionary phase and debt it still accumulated. Criticisms of ** countercyclical fiscal policy ** argue that in practice the use of countercyclical policy is easier said than done. If the right amount of adjustment can be determined it takes time to implement and is slow to take effect. Another limitation of ** countercyclical fiscal policy ** is that it can cause crowding out.  · “The ** crowding out effect ** refers to the idea that the government borrowing to finance a deficit crowds out private investment because it causes interest rates to rise.” The last problem associated with ** countercyclical fiscal policy ** is that it does not take into account the impact it has on the governments’ budget. When the government is spending to close recessionary gaps, it spends more, taxes less and earns less in tax revenue because of people loosing their jobs or just earning less in general. This can lead to deficit spending.  · “A ** deficit ** occurs when the government spending on goods and services is in excess of their net tax revenues.” The problem with this school of thought is that when it is applied, it is very appealing to spend money during a downturn and help people when they need help. But it is also politically very attractive to be spending money and helping people during a boom time when it is not necessary. If a government wants to provide a number of goods and services to its people without having the immediate tax revenue to fund it, they can borrow the necessary money. “Usually governments do this by issuing securities, either Treasury Bills or Treasury Bonds.” These securities are obligations that make the government repay the borrowed amount at maturity while paying a stated interest rate for the life of the agreement. If deficit spending is practiced more often than not and starts to accumulate over a period of time, the size of the government’s national debt will grow. Increased deficits mean increased borrowing and more interest expenses, which mean fewer funds going the actual government programs. Debt can be a difficult situation to recover from as seen in the United States recently. However, “if a country borrows too much money, it has to pay a great deal of interest every year in order to service that debt. This represents money that could have been used to pay for program spending instead. By borrowing money, the government has placed a greater emphasis on spending in the present than in the future. It has discounted the value of future expenditure.” REFERENCES http://www.finpipe.com/fiscpol.htm John Sayre and Alan Morris, Principles for Microeconomics, McGraw-Hill Ryerson, 2009 pgs 383-401