Question

What are the two types of challenges faced by the government when it comes to implementing a stabilization policy (fiscal and/or monetary)?

Answer 1

Fiscal policies are controlled by the government and there are two tools through which this policy is implemented. The two tools are government spending and taxation. There are two types of fiscal policy: expansionary fiscal policy and contractionary fiscal policy.

Monetary policies are controlled by the central bank of the country and they make changes in the money supply by changing the interest rates. There are two types of monetary policy: expansionary monetary policy and contractionary monetary policy.

The two main challenges faced by the government when it comes to implementing a stabilization policy like fiscal or monetary policy are:

1. Time lag: There is a lag between the time when the problem arises in the economy which causes instability and the actual result of implementing the policies. Thus, when there is instability in the economy, the fiscal or monetary policies are implemented by the government, but the actual time when the policies show its effect is too late and the situation worsens. Thus there is a lag problem which is a major challenge in this.

2. Forecasting the right amount of fiscal or monetary policies that need to be implemented: It is usually difficult to analyze the coverage or impact of the instability in the whole economy. Since it involves the whole economy of the nation, to measure the impact over everything and then plan for a policy accordingly is very difficult. It is ideally not possible to match both and bring perfect results.