Question

Explain how long-lags in the effective implementation of fiscal problems can lead higher rates of inflation.

Answer 1

Every fiscal policy and monetary policy has some policy lags . We discuss fiscal policy here . Such policy lags can be categorized broadly under two heads : 1) Recognition , administrative and implementation lags . 2) Operational lag or time lag in working and achieving desired result .

An expansionary fiscal policy consists of government tax cuts and rise in government spending , this should shift the AD curve right . But there might be other factors that push AD left . This makes end result uncertain . Sometimes when fiscal policy is implemented during the recession phase and due to time lag it did not work , the economy automatically goes to boom phase rendering the policy ineffective when it should have been effective . So attempts to stabilize the economy may sometime result in more destabilization .

As the economy is pushed to E' , it means that there is more inflationary pressure in the boom phase when along with already expanding economy there is excess government spending and also tax cuts .