Question

Explain how each fiscal policy influences GDP.

Expansionary Fiscal Policy - Increases in government expenditures and/or decreases in taxes to achieve particular economic goals.

Contractionary Fiscal Policy - Decreases in government expenditures and/or increases in taxes to achieve particular economic goals.

Discretionary Fiscal Policy- Deliberate changes of government expenditures and/or taxes to achieve particular economic goals.

Automatic Fiscal Policy - Changes in government expenditures and/or taxes that occur automatically without (additional) congressional action.

Answer 1

Expansionary Fiscal Policy:

Increase in the government expenditure or decrease in taxes increases the aggregate demand in the economy and therefore increases the GDP level.

Contractionary Fiscal Policy:

This policy has the opposite effect. It decreases the aggregate demand and GDP level

Discretionary Fiscal Policy:

Deliberate changes made by the government such as a decrease in net taxes increases GDP level. Deliberate fall in net taxes increases disposable income which increases consumption and GDP level.

On the other hand, deliberate increase in net taxes decreases the GDP level.

Discretionary Fiscal Policy is used in response to an economic problem or shock.

Automatic Fiscal Policy

Under this, no action is taken by the government in response to the economic problem. In case of economic recession or inflation, automatic fiscal policies such as increasing unemployment compensation or reduction in marginal tax rates will increase the GDP level.