1.1 It is hard to estimate how much and
when exactly we need the policies
1.2 Time lags in the policy process:
measurement, decision, execution and
then effectiveness of policy changes
1.3 Changes in fiscal or monetary policy
affect other economic objectives - such
as the exchange rate, the trade balance
and the provision of public services
2.1 Monetary policy affects all
sectors of the economy
although in different ways
and with a variable impact.
2.2 Fiscal policy changes can be targeted to affect
certain groups (e.g. increases in benefits for low
income households, reductions in corporation tax
for small enterprises, investment allowances for
businesses in certain regions)
3 Time Lags
3.1 Monetary and fiscal policies have different time lags. Monetary policy is
extremely flexible (rates can be changed each month) and emergency rate
changes can be made in between meetings of the MPC, whereas
changes in taxation take longer to organize and implement. Because
capital investment requires planning for the future, it may take some time
before decreases in interest rates are translated into increased
investment spending. Typically it takes 6 -12 months or more before the
effects of changes in UK monetary policy are felt.
3.2 The impact of increased government spending is felt as soon
as the spending takes place and cuts in direct and indirect
taxation feed through into the economy pretty quickly.
However, considerable time may pass between the decision to
adopt a government spending programme and its
implementation. In recent years, the government has
undershot on its planned spending e.g. HS2.
4.1 When the economy is in a recession (confidence is low and deflationary
pressures are taking hold) monetary policy may be ineffective in increasing
current national spending and income. E.g. the problems experienced by the
Japanese in trying to stimulate their economy through a zero-interest rate policy.
In this case, fiscal policy might be more effective in stimulating demand. Other
economists argue that short term changes in monetary policy do impact quite
quickly and strongly on consumer and business behaviour. However, there may
be factors which make fiscal policy ineffective aside from crowding out.
Future-oriented consumption theories hold that individuals undo government
fiscal policy through changes in their own behaviour – for example, if government
spending and borrowing rises, people may expect an increase in the tax burden in
future years, and therefore increase their current savings in anticipation of this.
5 Expansionary policies
5.1 Monetary expansion - Lower interest rates
will lead to an increase in both consumer and
fixed capital spending both of which
increases current equilibrium national income.
Since investment spending results in a larger
capital stock, then incomes in the future will
also be higher through the impact on LRAS.
5.2 An expansion in fiscal policy (i.e. an increase in
government spending) adds directly to AD but if
financed by higher government borrowing, this
may result in higher interest rates and lower
investment. The net result (by adjusting the
increase in G) is the same increase in current
income. However, since investment spending is
lower, the capital stock is lower than it would have
been, so that future incomes are lower.
6 Fiscal policy should not be seen
is isolation from monetary policy.