Question

What is the difference between automatic stabilizers and discretionary fiscal policy?

Answer 1

Fiscal discretionary policies stabilise the economy. They come into force when the government passes new laws which change the level of tax or spending. Those measures are generally taken during either recessions or booms.

For example, during an economic crisis the government could implement this kind of fiscal policy to increase aggregate demand. These measures will help to restrain aggregate demand if the economy booms. They are meant to close a recessionary or inflationary gap. A discretionary fiscal policy will therefore most stabilize the economy when surpluses are incurred during inflation and deficits during recessions.

Automatic stabilisers balance output and demand in the same way as discretionary fiscal policies. The difference is that government spending and tax rate changes take place without any deliberate legislative action. In other words, they are not to be voted on by Congress. These measures can include (but are not limited to) incentives for employment, tax cuts, progressive taxation, farmers' subsidies and compensation for unemployment.

For example, the government will automatically spend more on unemployment benefits when the economy slows and people lose their jobs. People will earn more during economic growth and pay higher taxes whilst unemployment rates will fall. The government will therefore spend less.