Page 254 - DECO402_Macro Economics

Unit-27: Monetary Policy

At the end, if tax payers consider the tax reduction to be temporary then this policy will be less Notes
effective that is why this policy is more effective in controlling inflation by increasing taxes because
by high rates of taxes there will be a reduction in disposable income of people and businessmen, by
which there will be a reduction in total demand. Secondly, for controlling deflationary trends, second
method is more useful. With taxes remaining unchanged, if government increases its expenditure on
goods and services then total demand will increase equal to increase in government expenditure. At
the other side if government expenditure is reduced during inflation then it in not much effective,
because trader expectations of the economy are of high trade of which there is no possibility to reduce
effective demand. Third method is much more effective and better than the other two methods of stop
inflationary and deflationary trends. For stopping inflation, taxes must be increased and government
expenditure reduced. At the other side for facing depression, taxes may be reduced and government
expenditure may be increased.

Limitations

Discretionary fiscal policy depends on right time and correct forecast. First, correct forecast is necessary
to know that stage of the cycle through which the economy is passing. Only then it is possible that
complete fiscal activity may be done. Wrong forecast may instead of slowing the cyclical ups and
downs, may increase it. Actually, for correct forecasting, economics is not a complete science. As a
result, fiscal action is always taken when in the trade cycle, turn points have arrived. Secondly, there
are two time lags of public fiscal policy. First is “decision lag”, which is related to the time that is
taken in study of the problem and in taking the decision. Lag found in this process may be very long.
Secondly, once the decision is taken then “application lag” is there. In it that expenditure is found
which has been allocated for application of programme. In country like U.S.A, it may take more than
two years and in a country like U.K., more than a year. Thirdly, some public plans are so complex
that with an objective to increase or decrease expenditure on them, it is not possible to make them
slow or fast.

27.8 Summary

y In comparison to change in tax rates because of higher multiplier effect of government
expenditure, in comparison to expenditure tax changes may be applied much faster. That is why
for controlling cyclical ups and downs more emphasis is being laid on taxation in form of best
fiscal measure. In this manner, when turn point of trade cycle is already on then discretionary
fiscal policy gives power to built-in stabilisers, as is the experience of developed nations like
USA.

27.9 Keywords

y Fiscal Policy—Financial policy.
y Goals— objectives.

27.10 Review Questions

1. What do you understand by Fiscal policy? Tell the difference between three main types of
discretionary fiscal policy.
2. Analyse compensatory Fiscal Policy.
3. Do a critical analysis of automatic stabilisation.

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