Fiscal Policy's Toolkit and Its Three Lags: Stabilizers, Discretion, Crowding Out

The idea

The exam's fiscal-policy item asks what government can do with spending and taxes, when, and why economists doubt it, and the anchor's chapter answers in that order, with its judgments kept its own. What: fiscal policy is federal spending, taxation and borrowing; in recent decades federal spending and taxes have run about eighteen to twenty-two percent of GDP, state spending has risen toward twenty, and defense, Social Security, healthcare and interest take about seventy percent of the federal total, all the anchor's dated figures. Expansionary fiscal policy raises aggregate demand by more spending or lower taxes and fits an economy in recession below potential GDP; contractionary policy cuts demand by less spending or higher taxes and fits an economy above potential. When: some of it is automatic. Automatic stabilizers are tax and spending rules that soften a slowdown and restrain a boom without new legislation, since tax receipts fall and benefits rise on their own in a recession; the standardized employment budget shows what the deficit would have been at potential GDP, separating the stabilizers' work from discretionary policy, which is a new law changing taxes or spending on purpose. Why the doubt: discretionary policy must be recognized, legislated and implemented, three lags that can land the stimulus after the recession has ended; government borrowing can raise interest rates and crowd out private investment, reducing the demand it meant to add; temporary and permanent changes act differently; and the process is political. Many economists, the anchor says, conclude that discretionary fiscal policy is a blunt instrument best kept for extreme situations, and it judges the merits of a balanced-budget amendment questionable, since flexibility for wars and recessions is worth keeping. The deficit record it gives is chronological: wartime debt paid down in peace for most of the twentieth century, peacetime debt in the eighties and early nineties, surpluses from nineteen ninety-eight to two thousand one, deficits since two thousand two, very large ones in two thousand eight and nine.