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One major problem with fiscal policy is that it is very difficult to achieve all its economic objectives simultaneously using fiscal policy. Low unemployment and a good rate of economic growth are more likely to be achieved if there is a buoyant (high) level of aggregate demand in the economy. Conversely, a low rate of inflation and a Balance of Payments balance will be more likely to be achieved if there is a low level of aggregate demand in the economy. So, a government using fiscal policy is likely to be faced with a trade-off: increasing AD may reduce unemployment and raise economic growth, but at the cost of higher inflation and a worsening of the Balance of Payments.

This problem with fiscal policy became particularly apparent from the late 1970s onwards. The government was faced with rising inflation and rising unemployment at the same time. This was known as 'Stagflation'. What should it do in such a situation? Contractionary fiscal policy should help to reduce inflation, but at the cost of higher unemployment. Expansionary fiscal policy would have the opposite effect. Fiscal policy is not designed to deal with the problem of Stagflation and, as a result, lost importance from the 1970s onwards.

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