![]() How does discretionary fiscal policy affect the economy?ĭiscretionary fiscal policy affects the economy through its effect on aggregate demand. However, discretionary policies may be taken when the government’s automatic stabilizers are not strong enough to stabilize the economy. For example, it does not require the government to amend related laws and regulations or require parliamentary approval to take effect. Unlike discretionary policies, automatic stabilizers work without requiring deliberate government action. ![]() But, on the contrary, it will decline during an economic expansion as the unemployment rate decreases and households are more prosperous. Such spending will rise during a recession as the unemployment rate rises. Take unemployment benefits as an example. However, they work counter-cyclically, where the effect is inversely related to the current cycle. Some items in government spending and income rise and fall with the cycle of the economy. Sometimes we call it an automatic stabilizer. In contrast, nondiscretionary fiscal policy works automatically. Alternatively, the budget requires parliamentary approval before it becomes effective. For example, the government should change the tax law when it raises the tax rate. The government needs to intervene to stabilize the economy and avoid negative effects such as a spike in inflation or a recession.īudget changes require concrete action and approval before they are implemented. The discretionary fiscal policy requires the government’s deliberate action to change its budget. What is a discretionary fiscal policy and nondiscretionary fiscal policy? Stronger aggregate demand will encourage the economy’s output to increase. Thus, increasing spending and cutting taxes increases aggregate demand, prompting the economy to recover. As a result, they have more dollars to spend or invest. Meanwhile, lower taxes mean households and businesses charge less. And it also stimulates related businesses to increase activity. Building infrastructure creates jobs and income for households. An increase in government spending, such as infrastructure spending, increases aggregate demand. The government deliberately aims its budget into a deficit by increasing its spending, lowering taxes, or combining the two options. In these conditions, the government takes an important role. Thus, the economy is not strong enough to rely on them to stimulate growth. And they will reduce consumption and investment. As rational economic actors, they will save more as their income and profits deteriorate during this period. ![]() For example, the economy cannot rely on the private sector during a recession to recover. Keynesian economists argue about how important government intervention is to affect the economy. These changes aim to spur or moderate economic growth as needed. Meanwhile, changes in taxes affect government revenues as well as private sector consumption and investment. An increase in government spending has a direct impact on aggregate demand. The new budget will require approval or a vote before being implemented.īudget changes affect aggregate demand, ultimately affecting economic growth, inflation, and unemployment rates. It is deliberate because the government intends to change items in its budget or revenue to direct the economy to the desired condition. What’s it: Discretionary fiscal policy is a deliberate government policy to influence the economy by changing its spending and income. ![]()
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