Government Economic Policy is meant to smooth the actions of the business cycle. Aka. it is referred to as countercyclial, it counters the cycle.
Differentiate Automatic Stabilisers & Discretionary Fiscal Policy
Automatic Stabilisers are not drived by deliberate government action, but instead by policies that have already been enacted into law, things like centrelink resulting in Transfer Payments. Or increased Tax Revenue as a natural result of a more active economy.
Discretionary Fiscal Policy is the opposite, it is things like Jobseeker that the government deliberately puts in palce to deal with problems.
Similarities between Auto Stabilisers & Discretionary Fiscal Policy
Both Stabilisers & Disc. Fiscal Policy smooth out the business cycle, pulling it closer to the trend line, they compliment one another, amplifying the effect of their complementary.
Automatic Stabilisers
Automatic stabilisers refer to how government revenue and expenditure change as a result of changes in the busienss cycle. These are beyond the control of government. There is legislation that prevents the government changing some things here, atleast in the short-term.
Concept
AutomaticStabalisersDiagram.excalidraw
Automatic Stabiliser graph contains two lines
- The Tax Revenue Line
- The Tax Revenue line is positvely sloped, this is because as economic activity rises, the government makes more revenue.
- The Transfer Payments line (eg. Welfare)
- Whereas; the Transfer Payments line is negatively sloped, since claims on welfare fall as economic activity rises.
Example Scenarios
Slowing Economy
Starting from the budget balance point, if the economy slows, then tax revenue will slow, and Transfer payments will rise, automatically pushing us a budget deficit
Expanding Economy
Starting from the budget balance point, and the economy expands, tax revenue will increase, and transfer payments fall, automatically, pushing the budget towards surplus
Impact of Automatic Stabilisers
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Automatic stabilisers cause the budget to vary over the course of the business cycle. They affect / are the Structural Component of the Budget.
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Income taxes & transfer payments act like an economic shock absorber
- In a economic boom, Income Tax rise, and Welfare/Transfer payments fall, preventing them from rising too much. In this way itacts like an economic shock absorber.
- In a economic bust, Income Tax is low, and Welfare/Transfer payments are high, pushing up economic activity in a time where it isusually falling.
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Simply; Income taxes and trasnfer payments act as a economic shock absorber in that; they increase the economy in a downturn, and decrease it in a upturn.
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Automatic Stabilisers do not completely mitigate peaks and troughs, only dampen them..
- BC with Stabilisers.excalidraw <- Incomplete
Discretionary Fiscal Policy
- Discretionary Fiscal Policy is ”deliberate changes to the The Budget that the government makes to stabilise the economy.”
Examples of Discretionary Policy - Source
- Reducing income tax to increase household purchasing power;
- Cutting corporate tax to stimulate businesses to spend on inputs, employment, and investment
- Increasing government spending on Infrastructure
- e.g. Transport & Communications projects
- Direct payments to households and/or firms
Expansionary Policy Stance
A Expansionary stance is useful to help stimulate spending. It is usually assosciated with a Budget Deficit, meaning, Planned Expenditure is higher than revenue.
Using the Keynesian Models to Analyse Fiscal Policy
Expans. Stance - Aggregate Expenditure Model
Can also show this using the ADAS model
- Economic Growth Increases
- Low levels of Cyclical Unemployment
- Moving up to 4%
Expans. Stance - Aggregate Demand & Supply Model
The government takes an expansioanry policy stance, taking on a budget deficit using some of the Discretionary Methods of Fiscal Policy, this causes the AE line to increase up to the level of Full employment, closing the gap.
The effect of their rise in Discretionary G2 Spending (
#ask_davis why does this cause multiplier, isn’t discretionary g2 spending not autonomous?
Expans. Stance - Aggregate Demand & Supply Model
can also describe this using the ADAS model