Question

Discuss the various fiscal policy levers used by politicians and bureaucrats to guide the economy in the direction they deem most beneficial. Detail the effects of discretionary fiscal policies, the impact of crowding out, time lags, and automatic stabilizers. How do these policy actions change your behavior regarding spending and saving?

Answer 1

Discretionary fiscal policy is initiated by an act of the government . It is not triggered automatically by the state of the economy . Changes in government purchases and changes in net taxes are instruments in this policy .

Government can increase spending in normal budgetary schemes or infrastructural spending . This increase in spending occurs during recession when this additional aggregate demand created helps to dole the economy out of recession . The opposite occurs during inflation . Net taxes are decreased which increases disposable income , so consumption increases which increases real GDP demanded . The opposite occurs during inflation when net taxes are increased to control inflation .

High government investment or public sector spending causes increase in demand for money . This increases the equilibrium interest rate . So this drives out private investment or partly offsets the effect of expansionary fiscal policy . This is termed as crowding out effect .

Time lags are of different kinds : recognition time lag ( time to recognize the state of economy ) , action time lag ( time required for the policy to be effective ) , effect time lag ( time for fiscal policy to give results and effect the economy ) .

Automatic stabilizers such as corporate taxes and personal taxes are such instruments which can automatically stabilize the economy without government action .

Right policy actions taken by government establishes confidence of citizens on the economy and helps to make right expectations . So behavioural changes in spending and saving are more organized and predictable .