Th2.6: Problems when Evaluating Fiscal Policy

Question 1

What are the five problems when evaluating fiscal policy?

Answer 1

impacts LRAS
inequality and incentives
political issues
austerity
depends on the multiplier

Question 2

Impacts LRAS

Answer 2

government spending impacts LRAS. for example, by cutting government spending to reduce AD, the government are reducing the quality of other things like education

Question 3

Inequality and Incentives

Answer 3

taxes and spending have an impact on inequality, so some decisions aimed to reduce / increase demand may improve may increase income inequality. also have an impact on incentives, e.g high taxes reduce incentives

Question 4

Political Issues

Answer 4

government has to worry about political issues, as raising taxes in order to reduce demand may lead to them being voted out of office

Question 5

Austerity

Answer 5

expansionary fiscal policy is difficult to undertake during a period of austerity. the government needs to consider the effect of policies on the budget

Question 6

Depends on the multiplier

Answer 6

impact of fiscal policy depends on the multiplier - the bigger the multiplier the bigger the impact on AD.

Question 7

What do classical economists and Keynesians argue about the multiplier?

Answer 7

classical economists argue the multiplier is almost zero while Keynesian economists argue it can be large if targeted correctly