Domestic Policy Practice Test

When fiscal policy is used to counter a recession with tax cuts, the timing matters because stimulus effects unfold over time. Cutting taxes raises people’s disposable income and can encourage more spending, and it can also boost business investment as after-tax profits look more attractive. But households and firms don’t adjust their plans instantly. It takes time for individuals to change spending habits, some of the extra income may be saved, and businesses need months to respond by hiring, producing more, or investing in capital. There’s also the lag involved in the policy becoming law and then taking effect in the economy. In the 1960s recession, the tax cuts helped, but the impact appeared gradually rather than right away. That’s why the best description is that they took a long time to work.