Question

Briefly discuss the effects of time lags in relation to fiscal policy, including: a comparison to monetary policy, what ...


Briefly discuss the effects of time lags in relation to fiscal policy, including: a comparison to monetary policy, what the level of fiscal policy will be, and its effect on fiscal policy during recession.

Answer

Fiscal policy’ refers to the use of ‘government revenue collection’ & expenditure to influence the economy of a country. In a situation where the economy is in a state of recession, that time the government makes some decisions or policies known as fiscal policy, which includes increasing government expenditure or changing the tax rate.

If there is an occurrence of the time tag in the fiscal policy then it may become more difficult to analyze or quantify because it takes a time period to actually occur. The effects of time lags in relation to fiscal policy are as follows:

1. Rates of interest - If there is a change in the interest rate, let's say a rise in rate makes the borrowing more expensive. But if there are new firms who have just started investing and starting up, it will not stop just because of the cost of borrowing and the business will continue at higher rates only.

2. Rise in the investment level also includes time lags. 

Whereas, the first source of time lag in monetary policy is the slow down in the pass-through implementation of changes in the overnight rate of cash into other rates of interest. 

 

At the time of recession, the government may implement or use the fiscal policy which is expansionary in nature by declining the rates of tax to raise the AD {aggregate demand} and enhance the growth of the economy. But these policies have time lags in the sense that to determine that a recession has occurred, the government of the nation takes time. Moreover, fiscal policy to get passed and implementation will be delayed.

 

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