Discretionary Fiscal Policy

Updated Feb 14, 2023

Discretionary fiscal policy refers to the deliberate and intentional use of government spending and taxation to stabilize the economy and achieve specific goals. It involves the manipulation of government revenue and expenditures to achieve macroeconomic objectives, such as full employment, price stability, and economic growth. In this blog post, we will define discretionary fiscal policy, discuss different types, and compare it to monetary policy.

Definition of Discretionary Fiscal Policy

Discretionary fiscal policy is a type of fiscal policy that is implemented by the government at its own discretion (hence the name). It involves the use of government spending and taxation to influence the economy. That means the government can either increase spending or reduce taxes to stimulate the economy or decrease spending and increase taxes to slow it down. This type of fiscal policy is implemented in response to specific economic conditions or to achieve specific policy goals. Thus, it is in contrast to automatic fiscal policy, which involves automatic changes in government spending and taxation in response to changes in the economy.

Types of Discretionary Fiscal Policy

Fiscal policy is an important tool that governments can use to manage the economy and achieve sustainable growth. There are two main types of discretionary fiscal policy: expansionary fiscal policy and contractionary fiscal policy.

Expansionary Fiscal Policy

Expansionary fiscal policy refers to actions taken by the government to stimulate economic activity. This type of policy involves an increase in government spending or a decrease in taxation, which leads to an increase in aggregate demand. The goal of expansionary fiscal policy is to boost economic growth and reduce unemployment.

For example, during a recession, the government may increase spending on infrastructure projects or provide tax cuts to individuals and businesses. This increased spending or reduced taxation results in increased consumer spending and investment, which in turn stimulates economic growth and reduces unemployment.

Contractionary Fiscal Policy

Contractionary fiscal policy, on the other hand, involves a decrease in government spending or an increase in taxation, with the goal of slowing down economic activity. The objective of contractionary fiscal policy is to reduce aggregate demand and control inflation.

For example, during a period of high inflation, the government may decrease spending on government programs or increase taxes to reduce consumer spending. This decrease in spending or increase in taxes leads to a reduction in aggregate demand, which helps to slow down economic growth and control inflation.

Balancing the Two Types

Both expansionary and contractionary fiscal policy have their pros and cons, and it is important for governments to carefully consider the impact of each policy on the economy. The appropriate type of fiscal policy will depend on the current state of the economy and the government’s goals.

For example, during a recession, the government may implement an expansionary fiscal policy to stimulate economic growth and reduce unemployment. By contrast, during a period of high inflation, the government may implement a contractionary fiscal policy to control inflation. And finally, in times of economic stability, the government may choose to maintain a neutral fiscal policy to avoid disrupting economic activity.

Discretionary Fiscal Policy vs. Monetary Policy

Discretionary fiscal policy and monetary policy are two of the main tools governments can use to stabilize the economy and achieve specific goals. While fiscal policy involves the manipulation of government spending and taxation, monetary policy involves the manipulation of the money supply and interest rates by the central bank.

Both policies are used to achieve similar goals, such as full employment, price stability, and economic growth. However, they are implemented differently and have different impacts on the economy. While discretionary fiscal policy can take several months to have an impact on the economy, monetary policy can have an immediate impact. In addition to that, discretionary fiscal policy is subject to political considerations and may take a long time to implement, whereas monetary policy is more flexible and can be quickly adjusted to changing economic conditions.

Summary

Discretionary fiscal policy is a powerful tool for governments to stabilize the economy and achieve sustainable growth. The government has the ability to choose when and how to implement changes in government spending or taxation, with the goal of influencing economic activity. The two main types of discretionary fiscal policy are expansionary fiscal policy and contractionary fiscal policy, which aim to increase or decrease aggregate demand, respectively. Discretionary fiscal policy should be used in conjunction with monetary policy to achieve the best results for the economy.