Crowding Effect and Other Economic Terms

¶ … lags are when it comes to enacting and applying fiscal policy. The second question asks about the notion of a political business cycle. The third question asks about how the expectations of a near-term policy reversal weakens when tax rates change. Finally, there will be a description of what is called the crowding out effect.

When it comes to "time lags" with fiscal policy, this basically refers to the fact that there is a time lapse between the time that a piece of fiscal legislation is passed and point in which results can be seen or measured. For example, when the fiscal stimulus passed (the ARRA) in 2009, there was expected to be a gap between the time it was passed and the time it showed any sort of demonstrable effect on the economy (Economics Online, 2015).

As for the political business cycle, Auburn University describes that term as meaning "a business cycle that results primarily from the manipulation of policy tools (fiscal policy, monetary policy) by incumbent politicians trying to stimulate the economy….." The aforementioned ARRA would be an example of that as well (Auburn, 2015). Tax rates would certainly have an effect on policy reversals and changes since tax rates would be one of the major (but certainly not the only) thing that affects tax revenues and overall economic activity.

For example, some may hold that a lowering of tax rates might raise revenues due to increase economic activity while others may hold that it would decrease revenues overall. It could certainly go both ways depending on the factors involved. An example of it going generally badly would be Kansas and with Governor Brownback. He lowered taxes to spur economic growth and shortfalls followed. Indeed, tax rates are just one consideration when it comes to the ebbs and flows of fiscal policy (Haltiwanger, 2013).

Lastly, there is the definition of the "crowding out effect." Per Investopedia, the term refers to when the public sector replaces or otherwise inhibits private sector spending. Put another way, it is when "government must finance its spending with taxes and/or with deficit spending, leave businesses with less money and effectively 'crowding them out' " (Investopedia, 2015). Conclusion Fiscal policy can be a very complicated thing. It is not an exact science and it is very hard to differentiate between causality and simple correlation when it comes to economics.

Even so, there are general tenets that are usually followed and they generally seem to work more often than not. When the economy goes sour, interest rates go down and encouragement of investment goes up. Taxes.