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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

what is barter system
twinkel Reply
a system in which goods are exchanged for other goods
Barter system is said to be the process whereby goods are being exchange for goods
a system in which money have not play any role
goods and services are exchanged .. problem is finding equitable or agreeable value for the exchange of the goods or services.. I teach maths privately and love home made cake, I decided 4 home made cakes was worth an hour of private maths 😁
ok.thank u
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accounts in balance of trade
Kamuyu Reply
What is fiscal policy and intrest rates
Attah Reply
fiscal policy is the use of govt. revenue collection and expenditure to influence the economy.
income and expenditure
Bittu Reply
Macro economics : it is the study of all aggregate of all economic activities of an economic as whole.
Rajat Reply
what is macro economics
Sarah Reply
it is study of all aggregate of all economic activities of an economic as whole.
Macro economics is the aggregate study of national income, investment, price level, changes in economic activities, GDP and economic inflation.
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what is comparative and superlative advantage? give an example
Xanaan Reply
Methods used to correct trade deficits?
David Reply
what is role capitalism unemployment?
Mafsuud Reply
being unemployment look job but not achieved their being out labor force is person can't work
being unemployment look job but not achieved their being out labor force is person can't work
themes studied in economics include?
Patrick Reply
Financial accounting GDP and GNP
Samson Reply
can u explain
this means that the demand curve have negative relationship with the price ..which means that when high price low demand of the product and vice versa so higher price will shirnk the demand of product
Ahsan Reply
Higher price level ∴Real value of household wealth increase ∴Net export decrease ∴More money needed, interest rate increase, investment decrease
net export decrease
a person has 60birr to buy two commodities,x and y the price of x is four birr unit the price of y is two birr unit his utility functio given by u=xy+2x determine the budget equation
Mohammed Reply
the budget equation will be- 60 birr= 4x+2y
What are the various reasons for the Federal Reserve to increase the fed rates?
What is unemployment
Mijash Reply
Unemployment is a term used to describe people who do not hold a paying job
what are the causes of unemployment
unemployment refer to the situation in which people searching job but they have no. it also refers in which marginal productivity in zero.
Causes of unemployment are: 1: Over Population 2: Break down of the family system 3: Rural/Urban Migration
unemployment simply means, in the situation where by people are looking for a job and their could achieve it.
unemployment is a situation where by one has the ability to work but is not given a job

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