Stabilization

Stabilization

When governments attempt to control the economy through fiscal policy, they are applying what is known as stabilization policy. These policies are used in attempt to move the economy closer to full employment or potential output (Sheffrin & O'Sullivan 2006. pp.548). Some problems can occur, though, when trying to stabilize the economy. Such a problem is accidentally making the economic problem worse due to an ill-timed policy.

There are two main causes for policy lags. They are inside and outside lags. The reason for an inside lag is it takes time to devise a policy. Inside lag involves recognizing the problem, figuring out how to combat the problem, and enacting the proper procedures to fix the problem. Outside lag, on the other hand, is the time in which the policy takes to start working (Sheffrin & O'Sullivan 2006. pp.548-550).

The main danger of lags is its affect on unforeseen economic conditions. If an expansionary policy is adopted, but the economy was on a short decline and is doing well now, then the policy would help to over-heat the current economy causing problems. The opposite of that is if a contractionary policy is enacted. By the time it takes effect, the economy could be slowing down to a normal level. The policy, though, plunges the economy down into a recession. These are the dangers with stabilization policies (Sheffrin & O'Sullivan 2006. pp.548-550).

The main ingredient to successful stabilization policies is the economists' ability to accurately forecast the economic conditions down the road around the time that a policy would affect. This could be something that the government is facing in the case of the GDP increasing only three quarters of what was expected. First, economists probably took too long to recognize a problem on the horizon. Once that problem was recognized,