Lesson 5 of 5 · 14 min
Fiscal stance and the difficulties of implementation
The actual deficit is a poor gauge of policy because it moves with the cycle and with inflation, so analysts use the structural (cyclically adjusted) deficit, and even well-judged policy is hampered by lags, uncertainty and wider macroeconomic limits.
In short
- The structural (cyclically adjusted) deficit is the deficit that would exist at full employment; it is the preferred indicator of fiscal stance.
- The actual deficit can widen in a recession through automatic stabilizers even if policy has not changed.
- Inflation distorts the deficit: only real interest on debt is a true cost, because inflation erodes the debt's real value.
- Policy is expansionary if the (structural) deficit rises and contractionary if it falls; higher spending is not automatically expansionary if taxes rise more.
- Recognition lag, action lag and impact lag delay discretionary policy; forecasts are unreliable and private behaviour reacts.
- Other limits: inflation risk, market resistance to large deficits, uncertainty about full employment, supply (not demand) shortages, and crowding out.
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