1. Drawbacks & Limitations of Fiscal Policy

2. 1. Time Lags It takes time to :
recognize a problem exists (recognition lag)
decide on best course of action (decision lag)
figure out details of where & how much to spend/cut from which areas (implementation lag)
see the full effects of the plan once it is up and running (impact lag)
may take years for full effect – economy may have self corrected by then
stimulus applied at wrong time may just cause inflation
cuts applied at wrong time may create/worsen recession

3. 2. “Political considerations”
Tax increases are unpopular with voters
Cutting spending difficult if programs are popular with citizens (voters)
gov’t up for re-election may make spending/taxation promises it may have to keep (finance with debt) later

4. 3. Different levels of gov’t
Federal gov’t fiscal policies may with provincial fiscal actions
Ex. Fed’s institute contractionary policy while large provincial gov’t enacts expansionary policy
Policies may cancel each other out

5. 4. Regional variations…
If one region (ex. Ont.) is doing well while another region is suffering (ex. Atlantic prov’s), what policy should be used?
Expansionary policy could create inflation in Ont.
Contractionary policy could make Atlantic recession worse

6. 5. Size of Nat’l Debt
expansionary policy may require more borrowing/deficit spending
increases size of nat’l debt, debt to GDP ratio, etc. – politically risky; can affect nation’s credit rating
debt places increased burden on future generations to repay

7. 6. “Crowding Out”
Gov’t borrowing to fund stimulus programs increases competition for funds
Drives up interest rates for everyone
Smaller private borrowers (firms, households) can’t compete/afford higher rates
Private investment “crowded out”: less investment in capital goods (machinery, etc.); less production & employment; economic growth slows