Discretionary fiscal policy action
From the previous post we know that fiscal policy is formulated by the Government and not the central bank. Discretionary fiscal policy action is the action that is taken by the government to change the fiscal policy at its discretion according to the situation of the economy and its macroeconomic goals. During recessions, the fiscal policy action is kept expansionary by reducing taxes and increasing government spending to spur economic growth. Conversely in boom times, the fiscal policy is made contractionary by increasing taxes and reducing spending to rein in inflation and control economic growth.
Fiscal policy action tends to suffer from three types of lags. First is lag in recognizing the problems the economy is suffering from. Second is action lag, wherein the government takes time to discuss and implement fiscal policy changes. Third is impact lag, which is the time it takes for the full impact of the fiscal policy changes to be felt. Due to these lags, the fiscal policy changes may take too long to take effect and the economy may have already turned the next corner by the time the impact of the changes are felt.
Expansionary or contractionary fiscal policy
Whether the fiscal policy action is expansionary or contractionary is often judged by economists by the changes to the budget surplus or deficit. When the budget is in deficit, i.e. expenditure is more than tax revenue it is most likely indicative of an expansionary fiscal policy action and when the budget is in surplus it is most likely indicative of a contractionary fiscal policy action.
However budget surplus and deficit need not always be indicative of the fiscal policy decisions. The budget may be in surplus or deficit just because of the natural state of the economy. For example, in a recession the taxes collected will be naturally low and social security and unemployment benefits paid out will be high due to which the budget may be in deficit and not because of fiscal policy changes.
Interaction of monetary policy and fiscal policy
Read all about monetary and fiscal policies here below;
Expansionary fiscal and monetary policy:
In this scenario, interest rates will be low, supply of money and credit in the economy will be high thus increasing demand. Both private and public sectors will expand.
Contractionary fiscal and monetary policy
In this scenario, the interest rates will be high and demand will be low. Both private and public sectors would contract.
Expansionary fiscal policy and contractionary monetary policy
In this scenario, the government borrowing would be high. So interest rates will be high due to increased borrowing as well as contractionary monetary policy. Demand will be high due to increased spending by the government and less taxes.
Contractionary fiscal policy and expansionary monetary policy
In this scenario, interest rates will be low due to decreased government borrowing and expansionary monetary policy. Supply of money and credit in the economy will be high. Due to decreased government spending due to contractionary fiscal policy action the private sector will benefit at the cost of the public sector.
And that brings us to the end of the discussion on fiscal policy…. Thanks for reading….…. tell me if you liked the post….if u think something more needs to be included let me know via comments…also don’t forget to share or pin the post 🙂
In the next post we proceed to a discussion on international trade…..bye until then…
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For solved examples please refer to the CFA Institute books or CFA study notes. The problems can be easily solved using the CFA institute approved financial calculators. Please refer to the CFA exam policy and CFA calculator guide.
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