Problem(s) with Fiscal Policy: Examining Unemployment Rate, Inflation, and Lag Effects

Fiscal Policy: Examining Unemployment, Inflation & Lag Effects

Prev Question Next Question

Question

Seeing that the unemployment rate is reaching new highs each month, several Senators group together to propose major tax cuts and spending increases to stimulate the economy. Both the increased spending and tax cuts will be implemented in the following January, more than six months away. Due to major public outcry, these bills pass through legislature very quickly. During the six months in between passage and implementation, the unemployment rate begins to fall.

Another year passes, now 18 months after the bill was first passed, and the economy is suffering from significant inflation. What problem(s) with fiscal policy does this illustrate?

I. recognition lag -

II. impact lag -

III. crowding out effect -

IV. rational expectations -

Answers

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E. F.

E

In this case, tax cuts and spending increases took approximately six months to enact. However, illustrating the recognition lag, by the time six months had passed, the economy was recovering. One year later, the economy is suffering from inflation. This is due to the fact that fiscal policy takes time to have its full impact, or impact lag. By the time the full impact was realized, the economy had recovered, and the fiscal stimulus caused inflation.

Prev Question Next Question