Discuss the Four Major Limits to Fiscal Policy

question 54

Essay

Discuss the four major limits to fiscal policy.
B. The first difficulty is related to the crowding out effect, in which a decrease in private spending follows an increase in government spending; this results in a net reduction or neutralization of aggregate demand. The second difficulty is related to the size of the economy, which is too large for government spending to have a meaningful impact on real growth or inflation. The third difficulty is related to the various lags in passing and implementing the policy plan. These lags make the timing to offset any aggregate demand shock difficult, so that they can actually make business fluctuations more variable. The above three difficulties arise from using fiscal policy to influence aggregate demand. The fourth difficulty is that fiscal policy is not effective in dealing with an economy experiencing real shocks.

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