Question

Some economists argue for the use of fiscal policy to solve economic problems; others argue against it. What are some of the arguments on both sides?

Short answer

The use of fiscal policy to solve economic problems can be both valuable and harmful. Advocates argue it can stimulate economic activity, reduce unemployment, and fight recession. Detractors state possible negative impacts such as crowding out of private sector, inflation, politically contentious decision making and implementation delays that can reduce its effectiveness.

Step-by-step solution

Define Fiscal Policy

Fiscal policy refers to the use of government revenue collection (taxation) and expenditure (spending) to influence a country's economy. The two main instruments of fiscal policy are changes in the level and composition of taxation and government spending in various sectors.

Arguments for Fiscal Policy

Advocates of fiscal policy argue that it can be used to fight recession and unemployment, via expansionary fiscal policy which involves reducing taxes and increasing government spending. This in turn is thought to stimulate economic activity by putting more money in people’s pockets (through tax cuts) or by directly buying goods and services (through increased spending). Boosting aggregate demand can lead to economic growth and reduce unemployment rates.

Arguments against Fiscal Policy

Critics of fiscal policy point out the possible negative effects, such as crowding out private sector investment and business due to increase in government borrowing. Increased government spending may also lead to inflation, especially if the economy is already at or near full employment. Moreover, changes in taxation and spending levels can be politically contentious, causing delays in implementation and uncertainty which can reduce the effectiveness of fiscal policy as a stabilisation tool.