Question

3. Discuss some of the challenges associated with expansionary fiscal policy (not less than 300 words)

Answer 1

Tax reductions Disincentives. Growing taxes to reduce AD may cause disincentives to function, if this happens, efficiency may fall and AS will fall.
Nevertheless, higher taxes do not automatically decrease labor opportunities if the effect of revenue exceeds the effect of substitution.
Side benefits on public investment. Reduced government spending (G) to reduce inflationary pressure may have an adverse impact on public services such as public transportation and education, causing market disruption and social inefficiency.

Poor information. Where the government has weak knowledge, fiscal policy will fail. For example, if the government thinks a recession is going to occur, they would raise AD, but if that prediction was incorrect and the economy grew too quickly, the government's intervention will trigger inflation.
Time lags behind. If government wants to boost spending – this will take a long time to filter into the economy, and it may be too late to do so. Spending plans are set only once a year. The execution of any changes to spending habits is also postponed.

Deficit in the Budget. Expansionary fiscal policies would lead to an rise in the budget deficit that has several negative effects. For the future, a higher budget deficit would entail higher taxes, which will trigger crowding out.
Certain AD-components. When the government uses fiscal policy, its success would also depend on the other components of AD, for example, when consumer trust is very low, lowering taxes does not contribute to an rise in consumer spending.

Depends on the influence of a Multiplier. Any injection adjustment can be enhanced by the multiplier effect, hence the multiplier size would be important. When customers save any extra money, it will have low multiplier impact and less efficient fiscal policy.
Crowding Out . Expansionary fiscal policy of increased government spending (G) to increase AD may cause crowding out when increased government spending results in a decline in the size of the private sector.
– For instance, if government spending rises it would need to raise taxes or sell bonds and borrow money, both strategies would reduce private consumption and investment. When this occurs, then AD won't increase