An economy is experiencing a recession and policy makers are considering using discretionary fiscal policy to eliminate the recessionary ga

Question

What will be an ideal response?

Answer 1

The limitations are law-making time lags, a shrinking area of law-maker discretion, problems estimating potential GDP, and difficulty making economic forecasts. The law-making time lag refers to the point that after all the Congressional debate is concluded and the act is finally signed into law, the lag involved means that the economy might no longer be in recession. The shrinking area of law-maker discretion points out that more and more of the government budget is "out of bounds" for change. For instance, the government is highly unlikely in the near future to decrease expenditure on Social Security. As the budget includes more of these "untouchables," there is less room left for changes needed for fiscal policy. The problem with estimating potential GDP means that the recession might be less severe than believed. As a result, fiscal policy might be too strong and although it eliminates the recession, the fiscal policy might increase real GDP so much that it moves the economy farther away from potential GDP. Finally, the difficulty making economic forecasts means that forecasters cannot be sure what will be the state of the economy when the fiscal policy is finally implemented. If the economy is naturally recovering from the recession and this recovery is not forecast, then when the fiscal policy is implemented, the policy might push the economy well past potential GDP.