Use of Discretionary Fiscal Policy to Stabilise Fluctuations in Real GDP
Discuss how the government can use discretionary fiscal policy and automatic stabilisers to stabilise fluctuations in real GDP. What tools does the government have at its discretion to stabilise the economy? Suppose the government decides to decrease income taxes. Show in a diagram and explain how this policy will lead to an increase in real GDP. Explain how potential output may be affected.
A discretionary fiscal policy refers to deliberate changes in the level of government spending, transfer payments or in tax rates in order to achieve macroeconomic goals such as full employment, price stability, and economic growth. An expansionary fiscal policy is designed to close a recessionary gap by changing aggregate expenditures such as an increase in government purchases or decreasing taxes. A contractionary fiscal policy might involve a reduction in government purchases or transfer payments, an increase in taxes, or a mix of all three to shift the aggregate demand curve to the left, which results a real boost in actual GDP level and helping the economy to recover. Automatic stabilisers refer to the tendency for a system of taxes and transfers, which are related to the level of income to automatically reduce the size of GDP fluctuations. When an economy has a contractionary output gap, there will be higher unemployment rate and consequently, less income tax collections and more people living on welfare benefits. The government at its discretion has tools such as the discretionary fiscal policy and automatic stabilisers to stabilise the economy. Non-discretionary fiscal policy can alter the levels of taxations revenue and transfer payment expenses recorded during times of real GDP growth and contractions.
When the government decreases taxes, disposable income(Y-T) increases. That translates to higher demand (spending) and increased production (GDP). The fiscal policy also affects the supply side as income rate rates and structure of government payments can influence
A discretionary fiscal policy refers to deliberate changes in the level of government spending, transfer payments or in tax rates in order to achieve macroeconomic goals such as full employment, price stability, and economic growth. An expansionary fiscal policy is designed to close a recessionary gap by changing aggregate expenditures such as an increase in government purchases or decreasing taxes. A contractionary fiscal policy might involve a reduction in government purchases or transfer payments, an increase in taxes, or a mix of all three to shift the aggregate demand curve to the left, which results a real boost in actual GDP level and helping the economy to recover. Automatic stabilisers refer to the tendency for a system of taxes and transfers, which are related to the level of income to automatically reduce the size of GDP fluctuations. When an economy has a contractionary output gap, there will be higher unemployment rate and consequently, less income tax collections and more people living on welfare benefits. The government at its discretion has tools such as the discretionary fiscal policy and automatic stabilisers to stabilise the economy. Non-discretionary fiscal policy can alter the levels of taxations revenue and transfer payment expenses recorded during times of real GDP growth and contractions.
When the government decreases taxes, disposable income(Y-T) increases. That translates to higher demand (spending) and increased production (GDP). The fiscal policy also affects the supply side as income rate rates and structure of government payments can influence