<< Chapter < Page Chapter >> Page >

Visit this website to read about how the recovery is being affected by fiscal policies.

Political realties and discretionary fiscal policy

A final problem for discretionary fiscal policy arises out of the difficulties of explaining to politicians how countercyclical fiscal policy that runs against the tide of the business cycle should work. Politicians often have a gut-level belief that when the economy and tax revenues slow down, it is time to hunker down, pinch pennies, and trim expenses. Countercyclical policy, however, says that when the economy has slowed down, it is time for the government to go on a spree, raising spending, and cutting taxes. This offsets the drop in the economy in the other sectors. Conversely, when economic times are good and tax revenues are rolling in, politicians often feel that it is time for tax cuts and new spending. But countercyclical policy says that this economic boom should be an appropriate time for keeping taxes high and restraining spending.

Politicians tend to prefer expansionary fiscal policy over contractionary policy. There is rarely a shortage of proposals for tax cuts and spending increases, especially during recessions. However, politicians are less willing to hear the message that in good economic times, they should propose tax increases and spending limits. In the economic upswing of the late 1990s and early 2000s, for example, the U.S. GDP grew rapidly. Estimates from respected government economic forecasters like the nonpartisan Congressional Budget Office and the Office of Management and Budget stated that the GDP was above potential GDP, and that unemployment rates were unsustainably low. However, no mainstream politician took the lead in saying that the booming economic times might be an appropriate time for spending cuts or tax increases.

Discretionary fiscal policy: summing up

Expansionary fiscal policy can help to end recessions and contractionary fiscal policy can help to reduce inflation. Given the uncertainties over interest rate effects, time lags, temporary and permanent policies, and unpredictable political behavior, many economists and knowledgeable policymakers had concluded by the mid-1990s that discretionary fiscal policy was a blunt instrument, more like a club than a scalpel. It might still make sense to use it in extreme economic situations, like an especially deep or long recession. For less extreme situations, it was often preferable to let fiscal policy work through the automatic stabilizers and focus on monetary policy to steer short-term countercyclical efforts.

Key concepts and summary

Because fiscal policy affects the quantity of money that the government borrows in financial capital markets, it not only affects aggregate demand—it can also affect interest rates. If an expansionary fiscal policy also causes higher interest rates, then firms and households are discouraged from borrowing and spending, reducing aggregate demand in a situation called crowding out. Given the uncertainties over interest rate effects, time lags (implementation lag, legislative lag, and recognition lag), temporary and permanent policies, and unpredictable political behavior, many economists and knowledgeable policymakers have concluded that discretionary fiscal policy is a blunt instrument and better used only in extreme situations.


Leduc, Sylvain, and Daniel Wilson. Federal Reserve Bank of San Francisco: Working Paper Series. “Are State Governments Roadblocks to Federal Stimulus? Evidence from Highway Grants in the 2009 Recovery Act. (Working Paper 2013-16).” Last modified July 2013. http://www.frbsf.org/economic-research/files/wp2013-16.pdf.

Lucking, Brian, and Daniel Wilson. “FRBSF Economic Letter-Fiscal Headwinds: Is the Other Shoe About to Drop?” Federal Reserve Bank of San Francisco . Last modified June 3, 2013. http://www.frbsf.org/economic-research/publications/economic-letter/2013/june/fiscal-headwinds-federal-budget-policy/.

Recovery.gov. “Track the Money.” http://www.recovery.gov/Pages/default.aspx.

Bastagli, Francesca, David Coady, and Sanjeev Gupta. International Monetary Fund. “IMF Staff Discussion Note: Income Inequality and Fiscal Policy.” Last modified June 28, 2012. http://www.imf.org/external/pubs/ft/sdn/2012/sdn1208.pdf.

Questions & Answers

how to print
Siti Reply
what is flow variable
Siyanda Reply
a flow is a quantity that can be measured over a specific period of time
is economics a social science or a pure science
Hilda Reply
social science
social science
social Science as a Subject and Pure science as a study
How to compute National income by using the expenditure approach
Bridget Reply
Briefly explain whether the discipline of economics is a social science or pure science( normative or positive)
Okafor Reply
different between absolute advantage and comparative advantage
mathematical economics
masele Reply
show some questions under this topic
why met worth is added with libilitys in the balance sheet
bijoy Reply
what are the implications of inflation targeting?
Alinaitwe Reply
maximize profit
What happens to the goods and money market if the government cuts public spending?
Harman Reply
then the government will be punished by the public
GDP, INFLATION, UNEMPLOYMENT & PRODUCTIVITY and then write a paragraph on the behavior of each variable after analyzing them graphically.
what is international trade
Stella Reply
International trade is the exchange of capital, goods, and services across international borders.
international trade is the exchange of goods and services across boundaries
international trade is the exchange of goods and services of country and abroad
international is the process of exchanges of value interm of goods and services along national frontier
Increase knowdge and skill. it save time and cost. Increase high Efficiency of production .
betta Reply
List kinds of Elastcity of Demand
Is a faster rate of economic growth always a good thing as compared to a slower rate? And why?
what is unemployment
Doctor Reply
it is a situation during which workers remain jobless.
is situation where people are willing to work but job are no available
what is inflation
Sheila Reply
Inflation is a major concern to global economists, and it affects people from all walks of life. It refers to the measure or rate by which the cost of goods and services rises and purchasing power declines. As prices increase, monetary value decreases—prompting consumers to spend less on goods and s
inflation is the persistence rise in price level
Inflation is the situation during which too much money is required to purchase too few goods.
inflation is continuous increase in general price level
it is the process where too much money pursuing fewer goods

Get the best Macroeconomics course in your pocket!

Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Macroeconomics' conversation and receive update notifications?