Demand Management and Fiscal Policy Essay examples -- Fiscal Policy In

Demand Management and Fiscal Policy Fiscal policy is the manipulation of aggregate demand using taxation and or government spending. The government tends to make most of its fiscal decisions in the annual budget, usually announced in March of each year. However, there are a number of problems in using fiscal policy to control aggregate demand - one of the most significant is the problem of time-lags. 1. Time Lags Many aspects of fiscal policy have a delayed effect on aggregate demand. Changing the fiscal stance can take some time to achieve. For example switching to an expansionary fiscal policy through increased government spending can take some time before the full multiplied effects are felt on the economy. If the government announced increased health service spending, there could be considerable delays, as various committees decide how best to allocate the new funding. Then, if some extra construction work is planned, contracts need negotiating and awarding, all before actual spending takes place. On top of all these delays, major capital projects such as new hospital extensions could themselves take some time to complete. The net effect is that there may be months if not years before the planned increased in government spending actually has its full effect on the economy. This scenario is equally appropriate if the government is intending to build more roads, employ more teachers, invest more in the military etc. Admittedly, a tax change is probably quicker to introduce, although often businesses need some advanced warning so they can accommodate any change - again building-in some delay. Question: So what is his the problem of this for demand management ? The danger is that if the government was attempting to reflate the economy ( ie boost AD ) because of a lack of demand and economic activity, by the time the expansionary fiscal policy takes effect - the economy could have entered an upswing. Thus the economy might end up being stimulated at exactly the most inappropriate time. This time lag in fiscal policy could lead to exaggerated swings in the trade cycle - increasing volatility and hence inducing more uncertainty. 2. Fine Tuning -------------- Fine tuning is difficult when using fiscal policy. This refers to the ability to manipulate taxes and spending plans to bring abo... ...there any benefits ? Alternatively, an interest rate decrease is likely to lead to some capital outflows and hence a weakening of the currency. 2. Interest rates and time lags There can be some delays before the full effects of interest rates change are felt on the economy. When the Bank of England push up rates for example, it will take some time for the full effects to filter through the economy. Some estimates put this delay as being as long as 18 months. This is because, some banks eg HSBC, NatWest may not immediately adjust their rates straight away. Even if they do, some individuals may have fixed rate loans or mortgages, or they have some period of fixed rate ( eg for the first 3 years of a mortgage). Therefore, these individuals will not have their discretionary income changed for some time. Individuals with outstanding amounts on credit cards may also benefit from a couple of months delay before they start to notice that their interest payments have started to rise. Nevertheless, interest rate changes are thought to be much faster acting that fiscal policy changes, as at least an interest change will have some immediate impact straight away.