If the economy is in recession then a government’s priority will be to stimulate growth; creating more employment is the best way to achieve this. More people employed and low interest rates means there is more money in the economy to be spent, which should create growth, and raise GDP. The government increasing it’s spending, i.e. investing in private sectors, will raise employment and is funded by taxation, national insurance contributions, and government borrowing. If the government wishes to change it’s spending in a recession period, an increase will hopefully re-stimulate the economy by increasing Aggregate Expenditure. Lowering taxes is another way of increasing aggregate expenditure, as with less tax to pay more of their income is disposable to them. In order to increase aggregate demand upwards the injections of money in to a household must outweigh the leakages. These methods are known as expansionary fiscal policy as spending goes up and taxes go down. See fig 1.

However there are problems with these policies as increasing spending can lead to a budget deficit. Therefore taxes can also be increased to accommodate this, this orientation of spending and taxes aimed at increasing the equilibrium of income, output and the employed is known as discretionary fiscal policy. By increasing spending and tax, the increase in spending will have a greater effect this is due to the balanced budget multiplier. This is caused by government spending being higher than the contractionary effects of taxes. Increased spending can also create the problem of ‘crowding out’ this is when public owned business challenges private business. The government does not want this as it would rather the private company provides the jobs, if the government does ‘crowed out’ sectors it is causing little benefit, and less effect to the economy.  In fact higher government spending can lead to higher interest rates due to all the borrowing that is going on which would cause a discouragement in private sector investment. The alternative measure of lowering taxes may not be as effective as increasing taxes as when tax is lowered although consumers have more money to spend, they will save more due to the fear of unemployment, increasing the amount of jobs does not create this attitude, and so more is spent. Fiscal policy is all about stabilizing the economy, however as hindsight shows it usually destabilizes economy, and does not fine-tune it. This is because there are fundamental problems with fiscal policy that have to be taken in to account. Fig 3 shows the effects of fiscal policy on the business cycle. Automatic stabilizers are used to smooth out the peaks and troughs in the business cycle. An automatic stabilizer counter acts the fiscal policy as when income rises then tax will rise, this reduces the size of the multiplier in order to prevent inflation, the opposite will happen when incomes are falling. Unemployment Benefits are another form of stabilizers because they provide the unemployed with money, aiming to maintain aggregate expenditure. During a recession these automatic stabilizers can reduce the effects of fiscal policy so causing fiscal drag.

            In theory fiscal policy is effective however there are practical problems that have to be highlighted and would affect policy making in a recession. This includes the size of change in which is involved, due to the scale and logistics it makes it hard to implement and inflexible. A lot of government spending is contractual and cannot be simply stopped and started easily, i.e. road building.  Timing is also another significant problem, as when is the best time to introduce the changes. Timing is unpredictable and there are time lags (time in which the implementation is recognized) as well as these economic forecasts are notoriously difficult to get right. This is especially true of inflationary fiscal policy as time lag means it wouldn’t take effect until the recession was over deeming it inappropriate. Essentially fiscal policy and increases in aggregate expenditure can cause increases in interest rates and inflation which in turn can lead to a decrease in growth and again an increase in unemployment and a movement towards unemployment.

In conclusion fiscal policy is only one of a number of measures a government can take to combat a recession. However as I have demonstrated there are a lot of shortcomings to this method as it has been proved to be inflexible. An alternative is monetary policy that controls the supply of money and inflation, which can be manipulated day to day. However the problem of a recession puts the government in a difficult position, both fiscal policy and monetary policy struggle to combat the effects of a downturn in economic growth. Essentially fiscal policy is slow to implement, can create a budget deficit, be less effective due to automatic stabilizers and create ill feeling due to taxation. Therefore fiscal policy is only one way of controlling the economy, if it is used in the correct way and along with monetary policy it can be an effective way of keeping growth buoyant. As long as a government recognizes where they may have problems these can be combated and recession dispersed.

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