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Criticisms of Fiscal Policy
Fiscal Policy is the use of Government spending and taxation to influence the level of economic activity. In theory, fiscal policy can be used to prevent inflation and avoid recession. But, in practise there are many limitations of using fiscal policy. Fiscal Policy explained
Evaluation / Criticism of Fiscal Policy
- Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall. However higher taxes do not necessarily reduce incentives to work if the income effect dominates.
- Side Effects on Public Spending. Reduced govt spending to Increase AD could adversely effect public services such as public transport and education causing market failure and social inefficiency.
- Poor Information Fiscal policy will suffer if the govt has poor information. E.g. If the govt believes there is going to be a recession, they will increase AD, however if this forecast was wrong and the economy grew too fast, the govt action would cause inflation.
- Time Lags. If the govt plans to increase spending this can take along time to filter into the economy and it may be too late.Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns.
- Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the budget deficit which has many adverse effects.Higher budget deficit will require higher taxes in the future and may cause crowding out (see below
- Other Componenets of AD. If the governmentt uses fiscal policy its effectiveness will also depend upon the other components of AD, for example if consumer confidence is very low, reducing taxes may not lead to an increase in consumer spending.
- Depends on Multiplier And change in injections may be increased by the multiplier effect, therefore the size of the multiplier will be significant.
- Crowding Out Increased Govt spending (G) to increased AD may cause “Crowding out” Crowding out occurs when increased government spending results in decreasing the size of the private sector.
- For example if the govt increase spending it will have to increase taxes or sell bonds and borrow money, both method reduce private consumption or investment. If this occurs AD will not increase or increase only very slowly.
- Also Classical economists argue that the govt is more inefficient in spending money than the private sector therefore there will be a decline in economic welfare
- Increased government borrowing can also put upward pressure on interest rates. To borrow more money the interest rate on bonds may have to rise, causing slower growth in the rest of the economy.
- Monetarist Critique. Monetarists argue that in the LR AS is inelastic therefore an increase in AD will only cause inflation to increase
Essays on Fiscal Policy
- Will the US economy benefit from Tax cuts
- Problems of Recovering from Recessions
- Discuss difficulties of controlling inflation
Essays and Revision Notes on Fiscal Policy
Problems of Government Borrowing in the UK
How Government finances national debt
WHat does Government Spend its Money On