Chapter 13, Problem 3P

To determine

The possibility of time lags to cause discretionary fiscal policy to destabilize real GDP

Concept introduction:

Time Lag- A delay in the implementation of the fiscal or monetary policy in response to a shock in the economy is the time lag in the economic context. This could be a recognition lag or a decision lag. While the former means the time lag between the occurrence of an economic shock and its recognition by the policy formulators, the latter is the time lag in taking a policy initiative post occurrence of a depression or a boom. An effectiveness lag on similar lines is the time the policy measures take to generate the desired results in the economy.

Fiscal Policy- The government policy related to the public revenue, borrowing and expenditure decisions is the fiscal policy of the country. It is generally founded on pre-determined rules founded in the constitution or other guiding authoritative structures. However, the government from time to time takes ad-hoc policy measures in response to economic turmoil in the country like a slowdown, depression, recovery or boom to affect factors like aggregate demand, savings, investment, income distribution etc. Such policy measures are called the discretionary fiscal policy measures.