What is Fiscal Policy?

During the 1930’s depression, it was glaringly evident that the free market economy did not have the built in stabilizer that the classical economist adamantly argued for. Instead, it was government intervention which stabilized the economy and brought the US out of depression. The tools used by the government to stabilize the economy were fiscal policy and monetary policy. This idea was propagated by none other than the legend himself J.M. Keynes. Both fiscal and monetary policy comes under macroeconomics.
There are two types of fiscal policies: discretionary and non-discretionary. Discretionary fiscal policy is where the government makes changes in the expenditure and taxes in order to control national output and prices. Nondiscretionary fiscal policy on the other hand is, built in tax or expenditure mechanisms which would increase demand in a recession and control demand in an inflation.
Discretionary policy during a recession is to increase spending. As I have explained before in my previous articles, during a recession private investment is nonexistent and only the government has the money to spend. When the country is facing a budget deficit, it can borrow money to fund the expenditure boost, or print more money and pump it into the economy. Taxes are also reduced during a recession in order to lessen the burden on the common man. During inflation, the best way to control it is to do the opposite of what is done in a recession. Decrease the expenditure and increase the taxes.
Nondiscretionary fiscal policy uses the tax code to bring in automatic flexibility in the rates that are paid by the citizens. Taxes like income taxes and corporate taxes change according to the money coming in. Therefore during a recession, the rates of these taxes will automatically go down. Unemployment compensation and welfare benefits are also nondiscretionary fiscal policies.



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