Economic policies aren't perfect
You’re a government. And you’ve got problems. Economic problems. Serious economic problems that require serious solutions. So you want to use your policies: fiscal, monetary and microeconomic. But wait! They’ve all got limitations.
Limitation one: Time lags
No policy has an immediate effect.
Here, we’ll distinguish between the implementation and effect of policies. The implementation refers to how long it takes to change a policy; effect is all about how long it takes the policy to affect the economy (change economic growth, inflation, etc).
Fiscal policy? It can be generally implemented once a year during the federal budget. And it can take effect quite quickly. Think about tax cuts: as soon as they are passed through Parliament, consumers will change their behaviour.
Monetary policy? The Reserve Bank of Australia meets once a month (except January), meaning the cash rate can be changed every month if required. So this policy can be implemented once a month. However, in terms of effect, monetary policy takes around 6 to 18 months to flow through the economy. So, longer than fiscal policy.
Microeconomic reform? It’s super complicated and expensive, so it can a long time to implement. And it could take decades to finish and have an impact on the economy. So long-term for both implementation and effect.
“Another thing to think about: governments want to be re-elected. So, they may not make tough policy decisions and be limited to safer, less controversial policies (which may not be the best for the economy).”
Limitation two: Political considerations
For fiscal policy and micro reform, the government might have to pass its changes through Parliament. If the government doesn’t have a majority in the Senate (ask me about this in the comments), they might have to compromise and scale back their plans to get them passed. This could limit the types of policies they can implement.
Another thing to think about: governments want to be re-elected. So, they may not make tough policy decisions and be limited to safer, less controversial policies (which may not be the best for the economy).
Monetary policy is conducted by the independent RBA so is free from political considerations.
Limitation three: Global factors
Governments may also face limitations in terms of what policies they can implement due to global conditions.
What do I mean?
One: there is a kind of global focus on specific policies, such as free trade, deregulation (labour markets, financial flows), free floating exchange rates and privatisation of government businesses. A government may face ‘peer pressure’ to follow these policies, even if wants to pursue an alternate policy.
Two: global economic conditions might dictate policy options. For example, there might be pressure on individual governments to run budget deficits during global downturns to support consumption and investment. This could risk plans for budget surpluses.