Question

Explain any two limitations of fiscal policy.

Point out main limitations of fiscal policy.

Answer 1

1. Lack of accurate forecasting: Accurate economic activity forecasting (boom or depression) is essential to the effectiveness of fiscal policy. However, a number of reasons limit fiscal policy.
2. Delay of decision: Fiscal policy decisions in democracies are predicated on the prior consent of legislature assemblies or parliament. The process is drawn out and time-consuming. Fiscal actions are therefore postponed. Additionally, the consequences of fiscal policy on output and employment take time to manifest when it is enforced.
3. Conflicting trends in public and private sector: Conflicting tendencies are perceived in both the public and private sectors, particularly in mixed underdeveloped economies. The demand for factors of production will rise if public investment is boosted to alleviate unemployment and depression in the economy. In the same way, prices will increase. Profit in the private sector will consequently decline. It will deter public sector investment. Fiscal measures will therefore turn out to be ineffectual.
4. Limitation of fiscal policy relating to full employment: Full employment is constrained by fiscal policy in numerous ways. The first is that pay rates will increase as a result of budgetary policies related to full employment. Instead of boosting production, monopolists will hike prices. As a result, the multiplier's value declines and employment will not rise as much as intended. Fiscal policy is unable to address the issue of structural unemployment.
5. Adverse effect on debt management: Numerous issues with debt management arise when fiscal measures are used to address the issues of unemployment and depression. Such actions actually increase the burden of public debt rather than providing a solution.
6. Problems of definite financing: Governments in less developed nations use extensive deficit financing as a budgetary tool. Excessive deficit financing might be detrimental. Price increases have a negative impact on economic growth.
7. Conflict between social and economic objectives: There are conflicts between fiscal policy and social and economic issues. For instance, the government invests a lot of money in public works projects during recessions. However, governmental spending is stopped during a boom era. In this sense, social and economic goals may clash with budgetary policy.
8. Adverse psychological reaction: Significant deficit funding derived from borrowing causes negative psychological effects. Investors are deterred by rumours of government insolvency, and capital flight frequently occurs.