Question

Briefly explain whether each of the following is (1) an example of a discretionary fiscal policy, (2) an example of an automatic stabilizer, or (3) not an example of fiscal policy. a. The federal government increases spending on rebuilding the New Jersey Shore following a hurricane. b. The Federal Reserve sells Treasury securities. c. The total amount the federal government spends on unemployment insurance decreases during an expansion. d. The revenue the federal government collects from the individual income tax declines during a recession. e. The federal government changes the fuel efficiency requirements for new cars. f. Congress and the president enact a temporary cut in payroll taxes. g. During a recession, California voters approve additional spending on a statewide high-speed rail system.

Short answer

(a) Discretionary Fiscal Policy, (b) Not Fiscal Policy, (c) Automatic Stabilizer, (d) Automatic Stabilizer, (e) Not Fiscal Policy, (f) Discretionary Fiscal Policy, (g) Discretionary Fiscal Policy.

Step-by-step solution

Identify Discretionary Fiscal Policy

Discretionary fiscal policies are non-compulsory adjustments (made at the discretion of Congress or similar body) that affect government income and spending. Examples in this exercise include (a), where the federal government increases spending on rebuilding the New Jersey Shore following a hurricane, (f) where Congress and the President enact a temporary cut in payroll taxes, and (g) where, during a recession, California voters approve additional spending on a statewide high-speed rail system.

Identify Automatic Stabilizer

Automatic stabilizers automatically change government tax or spending in response to economic changes without requiring any legislator action. Instances in this exercise include (c), where the total amount the federal government spends on unemployment insurance decreases during an expansion, and (d) where the revenue the federal government collects from the individual income tax declines during a recession.

Identify Non-Fiscal Policies

Items not directly related to government revenue (tax) or spending are not considered examples of fiscal policy. (b), where the Federal Reserve sells Treasury securities, is a monetary policy, not a fiscal policy. Additionally, (e) where the federal government changes the fuel efficiency requirements for new cars, is regulatory policy, not fiscal policy.

Key concepts

Discretionary Fiscal Policy

Discretionary fiscal policy refers to deliberate changes in government spending or taxation made by a legislative body, such as Congress or Parliament, intended to influence economic conditions. These policies are not automatic and require active decision making. For example, in a response to an economic downturn, the government might increase spending on infrastructure, such as rebuilding areas affected by natural disasters like the New Jersey Shore after a hurricane. This type of policy aims to boost aggregate demand and stimulate economic activity. Legislative bodies might also enact policies like temporary tax cuts to put more money into consumers' hands, thereby encouraging spending. In essence, discretionary fiscal policy allows governments to make targeted interventions to stabilize the economy.

Automatic Stabilizers

Automatic stabilizers are mechanisms built into government budgets, tax systems, and programs that automatically adjust to economic conditions without the need for new legislation. Unlike discretionary policies, they do not require specific decisions each time economic conditions change. For instance, during an economic expansion, government spending on unemployment insurance naturally decreases as fewer individuals require assistance. Conversely, during a recession, government tax revenues, such as individual income taxes, naturally decline as people earn less or lose jobs. These automatic changes help smooth the economic cycle by providing a stabilizing effect – curbing inflation during booms and cushioning the impact of recessions without the need for new government actions. This automatic adjustment supports economic stability with minimal bureaucratic intervention.

Monetary Policy

Monetary policy involves the management of a nation’s money supply and interest rates, typically conducted by a country's central bank, like the Federal Reserve in the United States. Unlike fiscal policy, which deals with government spending and taxation, monetary policy operates through controlling the availability and cost of money. In the example given, when the Federal Reserve sells Treasury securities, it is reducing the money supply, which can lead to higher interest rates. This type of policy is aimed at managing economic growth, reducing inflation, and maintaining currency stability. Because monetary policy is implemented by the central bank rather than through legislative action, it can be adjusted more quickly in response to changing economic conditions.

Regulatory Policy

Regulatory policy involves setting rules or standards in specific areas to influence behavior and business practices, often for social, environmental, or economic benefits. Unlike fiscal or monetary policies, regulatory measures do not directly affect a government's budget or interest rates but can have indirect economic impacts. For instance, when the government changes fuel efficiency requirements for new cars, it doesn’t alter government spending or revenues, but it influences the automotive industry and consumer behavior. Such regulations can drive innovation, promote environmental protection, and enhance public health. While not directly labeled as economic policies, their effects on industries and the broader economy can indeed be substantial, shaping market conditions over time.