Question

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

Short answer

Discretionary fiscal policy is characterized by active, deliberate changes in government spending or taxes to influence the economy, such as stimulus packages or tax cuts. Automatic fiscal policy, in contrast, involves measures embedded in the system designed to alleviate economic fluctuations without the need for active intervention, like unemployment benefits or progressive taxation which respond automatically to economic conditions.

Step-by-step solution

Definition of Discretionary Fiscal Policy

Discretionary fiscal policy refers to the government intentionally adjusting its spending and tax rates to influence the state of the economy. Examples of discretionary fiscal policy include a stimulus package in times of economic downturn or lowering taxes to boost consumption.

Definition of Automatic Fiscal Policy

Automatic fiscal policy, also known as automatic stabilizers, are policies that are built into the system in order to automatically adjust to economic fluctuations. Examples include unemployment benefits and progressive taxation. Unemployment benefits will automatically increase during a downswing, providing more spending in the economy. In the same economic situation, individuals will move into lower tax brackets due to decreased income, which helps to cushion the impact of the downturn.

Formulate the Distinction

The main difference between discretionary and automatic fiscal policy lies in the activeness of the approach. Discretionary fiscal policy is intentionally implemented, whereas automatic fiscal policy elements are embedded into the system and respond automatically to changes in the economic cycle.