Explain the problem of time lags in enacting and applying fiscal policy?

• What is fiscal policy?

Fiscal Policy is an economic term for the use of Government spending and taxation to influence an economy.

When a government purchases services and goods, the payments it distributes, and tax it collects to fund these purchases, are known as engaging fiscal policy.

The term fiscal policy tends to be used to describe the effect on an aggregate economy - the total demand for good and services, at a given time and price level. It is used to look at the overall levels of spending and taxation in an economy and most importantly the gap between them.

Fiscal policy proves an important tool for managing the economy, because it can affect the total amount of output produced, otherwise known as gross domestic product (GDP).

Fiscal expansion is used to raise the demand for goods and services, therefore increasing both output and prices. In times of recession and extreme unemployment an increase in demand will lead to more output, but without a change in price. While an economy in full-employment will conversely have a greater effect on prices but less impact on total output.

• Problems with applying fiscal policy

Fiscal policy may prove difficult to use for stabilization because of the inside lag/time lag. This is the gap between the time when fiscal policy is first needed, and when a government implements it.

For example if a recession or economic downturn can be forecast, then lag can be stopped or at least reduced, however this proves difficult for economists and fluctuations often occur.