Question

How is fiscal policy used to address problems in the economy? How are the short run and long run consequences of using fiscal policy different? What are the issues that complicate the task for policy makers of using fiscal policy to manage the economy?

Answer 1

Fiscal policy is a tool in the hands of the government to address problems or to affect real economic variables in the economy. The tools include government spending and taxation which also affect the state of the budget. The short run impact of fiscal policy is change in aggregate demand or total expenditure on goods and services in the economy. It is practised by increasing government spending or cutting down on taxes hence households will spend more of their disposable income on purchasing goods and services. The long run consequences of fiscal expansion is to play a stabilizinf role in business cycle which cannot be immediately resolved. The task for policy makers while using fiscal policy is the time lag between the implementation of the policy and the need of the policy. While sometimes monetary policy parameters also counter the effect of fiscal policy.