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Temporary and permanent fiscal policy

A temporary tax cut or spending increase will explicitly last only for a year or two, and then revert back to its original level. A permanent tax cut or spending increase is expected to stay in place for the foreseeable future. The effect of temporary and permanent fiscal policies on aggregate demand can be very different. Consider how you would react if the government announced a tax cut that would last one year and then be repealed, in comparison with how you would react if the government announced a permanent tax cut. Most people and firms will react more strongly to a permanent policy change than a temporary one.

This fact creates an unavoidable difficulty for countercyclical fiscal policy. The appropriate policy may be to have an expansionary fiscal policy with large budget deficits during a recession, and then a contractionary fiscal policy with budget surpluses when the economy is growing well. But if both policies are explicitly temporary ones, they will have a less powerful effect than a permanent policy.

Structural economic change takes time

When an economy recovers from a recession, it does not usually revert back to its exact earlier shape. Instead, the internal structure of the economy evolves and changes and this process can take time. For example, much of the economic growth of the mid-2000s was in the sectors of construction (especially of housing) and finance. However, when housing prices started falling in 2007 and the resulting financial crunch led into recession (as discussed in Monetary Policy and Bank Regulation ), both sectors contracted. The manufacturing sector of the U.S. economy has been losing jobs in recent years as well, under pressure from technological change and foreign competition. Many of the people thrown out of work from these sectors in the Great Recession of 2008–2009 will never return to the same jobs in the same sectors of the economy; instead, the economy will need to grow in new and different directions, as the following Clear It Up feature shows. Fiscal policy can increase overall demand, but the process of structural economic change—the expansion of a new set of industries and the movement of workers to those industries—inevitably takes time.

Why do jobs vanish?

People can lose jobs for a variety of reasons: because of a recession, but also because of longer-run changes in the economy, such as new technology. Productivity improvements in auto manufacturing, for example, can reduce the number of workers needed, and eliminate these jobs in the long run. The Internet has created jobs but also caused the loss of jobs as well, from travel agents to book store clerks. Many of these jobs may never come back. Short-run fiscal policy to reduce unemployment can create jobs, but it cannot replace jobs that will never return.

The limitations of fiscal policy

Fiscal policy can help an economy that is producing below its potential GDP to expand aggregate demand so that it produces closer to potential GDP, thus lowering unemployment. But fiscal policy cannot help an economy produce at an output level above potential GDP without causing inflation At this point, unemployment becomes so low that workers become scarce and wages rise rapidly.

Questions & Answers

how is the graph works?I don't fully understand
Rezat Reply
multiple choice question
Aster Reply
explain perfect market
Lindiwe Reply
In economics, a perfect market refers to a theoretical construct where all participants have perfect information, goods are homogenous, there are no barriers to entry or exit, and prices are determined solely by supply and demand. It's an idealized model used for analysis,
Ezea
What is ceteris paribus?
Shukri Reply
other things being equal
AI-Robot
When MP₁ becomes negative, TP start to decline. Extuples Suppose that the short-run production function of certain cut-flower firm is given by: Q=4KL-0.6K2 - 0.112 • Where is quantity of cut flower produced, I is labour input and K is fixed capital input (K-5). Determine the average product of lab
Kelo
Extuples Suppose that the short-run production function of certain cut-flower firm is given by: Q=4KL-0.6K2 - 0.112 • Where is quantity of cut flower produced, I is labour input and K is fixed capital input (K-5). Determine the average product of labour (APL) and marginal product of labour (MPL)
Kelo
yes,thank you
Shukri
Can I ask you other question?
Shukri
what is monopoly mean?
Habtamu Reply
What is different between quantity demand and demand?
Shukri Reply
Quantity demanded refers to the specific amount of a good or service that consumers are willing and able to purchase at a give price and within a specific time period. Demand, on the other hand, is a broader concept that encompasses the entire relationship between price and quantity demanded
Ezea
ok
Shukri
how do you save a country economic situation when it's falling apart
Lilia Reply
what is the difference between economic growth and development
Fiker Reply
Economic growth as an increase in the production and consumption of goods and services within an economy.but Economic development as a broader concept that encompasses not only economic growth but also social & human well being.
Shukri
production function means
Jabir
What do you think is more important to focus on when considering inequality ?
Abdisa Reply
any question about economics?
Awais Reply
sir...I just want to ask one question... Define the term contract curve? if you are free please help me to find this answer 🙏
Asui
it is a curve that we get after connecting the pareto optimal combinations of two consumers after their mutually beneficial trade offs
Awais
thank you so much 👍 sir
Asui
In economics, the contract curve refers to the set of points in an Edgeworth box diagram where both parties involved in a trade cannot be made better off without making one of them worse off. It represents the Pareto efficient allocations of goods between two individuals or entities, where neither p
Cornelius
In economics, the contract curve refers to the set of points in an Edgeworth box diagram where both parties involved in a trade cannot be made better off without making one of them worse off. It represents the Pareto efficient allocations of goods between two individuals or entities,
Cornelius
Suppose a consumer consuming two commodities X and Y has The following utility function u=X0.4 Y0.6. If the price of the X and Y are 2 and 3 respectively and income Constraint is birr 50. A,Calculate quantities of x and y which maximize utility. B,Calculate value of Lagrange multiplier. C,Calculate quantities of X and Y consumed with a given price. D,alculate optimum level of output .
Feyisa Reply
Answer
Feyisa
c
Jabir
the market for lemon has 10 potential consumers, each having an individual demand curve p=101-10Qi, where p is price in dollar's per cup and Qi is the number of cups demanded per week by the i th consumer.Find the market demand curve using algebra. Draw an individual demand curve and the market dema
Gsbwnw Reply
suppose the production function is given by ( L, K)=L¼K¾.assuming capital is fixed find APL and MPL. consider the following short run production function:Q=6L²-0.4L³ a) find the value of L that maximizes output b)find the value of L that maximizes marginal product
Abdureman
types of unemployment
Yomi Reply
What is the difference between perfect competition and monopolistic competition?
Mohammed
what are y=b+mx
Deva Reply
The equation y = b + mx represents a linear equation in slope-intercept form, where y is the dependent variable, x is the independent variable, m is the slope, and b is the y-intercept. The slope-intercept form of a linear equation is commonly written as y = mx + b, where m represents the slope of
Steven
Consider the following Total Revenue (TR) and Total Cost (TC) functions for a firm operating in a perfect competition market: TR = 6Q and TC = Q3 – 2Q2 + 50Q + 25 Determine the profit maximizing or loss minimizing equilibrium level of output. Compute the level of
Abdulwab Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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