Why Fiscal Policies May Fail

Why Fiscal Policies may fail

Fiscal policy is a manner that the government has to adjust its levels of spending in order to monitor and influence their economy by diverse stimulus, such as increasing in public expenditures or decreasing of taxes rates.

There are many reasons to explain why fiscal policies may fail, the first one is the possible limitation of the economy to generate more goods. This situation can be found in places that have very low level of unemployment, low level of technology or low production capacity. The increase in demand stimulated by a fiscal policy (public spending, for instance) will lead to increase in demand, that cannot be supplied; thus, prices tend to rise and inflation is expected to be higher.

In order to increase their spending, the government must finance their investments by increasing taxes or acquiring debt. If the State decides to increase the taxes in order to boost the economy, it might lead to a effect called "Crowding Out"; since, the population would have less money available to spend and probably, under the uncertainty about the taxes policy, they could consider saving more to be prepared for future taxes. Besides this, all debt must be paid in a given period of time; therefore, very probably, a loan in the present will result in a raise of taxes in the future.

Another pitfall for fiscal policies is the time it takes in order to be verified in the economy. It is known that the economy production fluctuates diachronically; thus, it might happen that the government decides to boost the economy during a dip period, in order to help the economy and reduce the fluctuation. Nevertheless, this increase in production might take some time to be felt and instead of reducing the dip, it might lead to a oversized peak, that could lead to inflation and instability in the economy.