The discussion on the discretionary fiscal policy, in a nutshell, suggests that the quicker and effective measures to remove recessionary gap is to raise the aggregate demand by reducing taxes and increasing public spending. And for closing an inflationary gap, the policy is to reduce aggregate demand by a combination of tax increase and curtailed government expenditure. However, these policy measures are not as easy to put into actual practice as they seem to be simple and workable in theory. This is because there exist so many problems or lags in formulation and implementation of these taxation and expenditure policies. Some of these problems are discussed below.
For formulating any suitable fiscal policy to remove the inflationary or recessionary GDP gaps, it is necessary that the size of the existing gap is known and taxation and expenditure policies changed accordingly. Estimating the size of the GDP gap requires large-scale surveys for collection of information and processing and compiling extensive statically data on demand, supply, output, prices etc., of a wide range of goods and services. This surely requires a lot of time. Thus, it is not possible to assess the output gap and design suitable measures immediately or without loss of time. There is a time lag involved in observing a gap and finding out its actual dimensions. This is called information gap. So, many a times polices are delayed due to long time gap in collecting information or even unavailability of complete and relevant information.
Even after assessing the size of the GDP gap, it is not easy to formulate and implement the required policy measures. Changes in tax policies and taxation structure is a time consuming decision. In a democracy, it has to go through many committees, passed by cabinet and voted by the parliament. There may be some past commitments to be honored, some welfare schemes to be carried forward and strengthened and some politically determined populist expenditures. Thus, the whole exercise of taxation and expenditure changes, even though economically sound has to meet political approval where divergence of views may cause long delays. Such delays between recognition of GDP gaps and the legislative measure to changes fiscal policies accordingly is called decision lag.
There is often a long-time gap between passing of laws and their implementation. The legislation may be enacted to change taxation and expenditure norms, but their actual implementation requires due notification, and information to all the concerned departments and agencies. In the bureaucratic setup of the government which is well known for its red tape and delays, the actual implementation of the policy measures thus takes a long-time. This is called execution lag. And when even these measures are actually implemented, it takes further more time to know their actual impact on the problem.
Because of these lags, it is quite possible that, by the time given policy decision has any impact on the economy, circumstance will have changed such that the policy is no longer appropriate.
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