Fiscal Drag

Fiscal drag happens when government’s net fiscal position ( minus taxation) fails to cover the net savings desires of the private economy, it is also called the private economy’s spending gap. The resulting lack of aggregate demand leads to deflationary pressure, or drag, in the economy, essentially due to lack of state spending or to excessive taxation.

One cause of fiscal drag is bracket creep, where progressive taxation increases automatically as taxpayers move into higher tax brackets due to inflation. This leads to moderation of  inflation, and can be characterized as an automatic stabilizer of the economy. Fiscal drag can also be a result of a hawkish stance towards government finances.

Consider the following statements:

  1. Fiscal drag is also called private economy’s spending gap.
  2. Bracket Creep is one of the causes of fiscal drag.

Which of the following statements is correct:

a) Only 1.

b) Only 2.

c) Both 1 & 2

d) None of the above

Answer: C