Economics » Government Budgets and Fiscal Policy » Practical Problems with Discretionary Fiscal Policy

Key Concepts and Summary

Key Concepts and Summary

Because fiscal policy affects the quantity of money that the government borrows in financial capital markets, it not only affects aggregate demand—it can also affect interest rates. If an expansionary fiscal policy also causes higher interest rates, then firms and households are discouraged from borrowing and spending, reducing aggregate demand in a situation called crowding out. Given the uncertainties over interest rate effects, time lags (implementation lag, legislative lag, and recognition lag), temporary and permanent policies, and unpredictable political behavior, many economists and knowledgeable policymakers have concluded that discretionary fiscal policy is a blunt instrument and better used only in extreme situations.

Glossary

crowding out

federal spending and borrowing causes interest rates to rise and business investment to fall

implementation lag

the time it takes for the funds relating to fiscal policy to be dispersed to the appropriate agencies to implement the programs

legislative lag

the time it takes to get a fiscal policy bill passed

recognition lag

the time it takes to determine that a recession has occurred

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