Problems with Fiscal Policy

Reduce incentive to work

Raising taxes on income and profits reduce work incentives, employment and economic growth. An effort to reduce aggregate demand may cause disincentives to work, if this occurs there will be a fall in productivity and Aggregate supply could fall.

Adverse effect of lowering Public Spending

Reduced govt spending to Increase Aggregate demand could adversely affect public services such as public transport and education causing market failure and social inefficiency.

‘Crowding out’ effect

With an increase in government expenditure, there will be greater competition for limited resources. This will offset private investments resulting in shrinking of the private sector.

Inaccurate forecasting

If the Government’s estimate or forecasting is wrong or inaccurate the Fiscal policy will suffer. For example, if a recession is expected and the government practises deficit budget, and yet the recession turns out to be a boom, this will cause inflation.

Implementation of the Policy

Planning for the spending is done once by most of the governments. If there is a delay in the implementation of the fiscal policy, it might reduce the effectiveness of the policy. Thus the time lag is important.