Difficulties in Executing Fiscal Policy

Recognition lag. The policymaker does not have complete information on how the economy functions. It may take several months for policymakers to realize that an economy is slowing.

Action lag. When policy changes are finally decided on, they may take many months to implement.

Impact lag. The result of these actions on the economy will take additional time to become evident.

These types of policy lags also occur in the case of discretionary monetary policy.

A second aspect of time in this process is uncertainty of where the economy is heading independently of these policy changes.

If the government is concerned with both unemployment and inflation in an economy, then raising aggregate demand toward the full employment level may also lead to a tightening labor market and rising wages and prices.

If the budget deficit is already large relative to GDP and further fiscal stimulus is required, then the necessary increase in the deficit may be considered unacceptable by the financial markets.

The level of full employment is difficult to measure accurately.

If unused resources reflect a low supply of labor or other factors rather than a shortage of demand, then discretionary fiscal policy will not add to demand and will be ineffective, raising the risk of inflationary pressures in the economy.

The issue of crowding out may occur.