What is Discretionary Fiscal Policy? Definition, Advantages, and Disadvantages

The economic condition of a country represents its present monetary state. It changes over time and depends on business cycles. Usually, as the economy fluctuates through periods of expansion and contraction, the economic condition also changes.

The former is considered positive, while the latter falls under adverse economic conditions. Nonetheless, economic conditions play a crucial role in dictating the economy.

Several factors can influence the economic conditions of a country. Usually, these fall under macro-and micro-economic factors. On top of that, the state of the global economy also influences those conditions.

One of the primary controllers of these economic conditions includes the government within a nation. It can control how the economy fluctuates over time. On top of that, the central bank can also influence those situations.

Governments use various policies to affect the economic conditions within a country. These policies fall under the fiscal policy term.

Similarly, they can have many types. One of those types includes the discretionary fiscal policy. This policy can have several advantages and disadvantages. Before discussing these, it is crucial to understand what fiscal policies are.

What is a Fiscal Policy?

A fiscal policy is a strategy that governments use to influence economic situations. Usually, it involves areas such as government spending and tax policies. Since these factors are within the control of a government within an economy, they fall under fiscal policies.

Similarly, fiscal policies primarily impact the macroeconomic conditions within a country. These include aggregate demand, employment, inflation, etc.

Governments use their collections to influence the fiscal policies in a nation. These collections usually include taxes or even tax cuts.

On top of that, these policies also involve expenditure. The primary purpose of using these policies is to influence the economic conditions. In most cases, the government uses these policies to move to a better stage in the business cycle.

However, fiscal policy does not include areas that the central bank within a nation can control. Instead, those areas fall within the monetary policy. Both can have their advantages and disadvantages. However, the primary difference is the body dictating how they work. On top of that, it also involves the areas these policies impact.

Governments can use several types of fiscal policies to influence economic conditions. These may be neutral, expansionary, or contractionary.

However, each type has its process and impact. Governments can collect funds from various sources to finance these policies. These usually include revenues collected through taxes. However, they may also involve borrowing, selling assets, seigniorage, etc.

Overall, fiscal policies refer to using government spending to influence economic conditions. It is one of the primary methods governments can use to impact economic conditions within a nation.

The term originates from the work of John Maynard Keynes through his Keynesian economics theories. Similarly, fiscal policies can influence various areas within the economy. It has many types, one of which includes the discretionary fiscal policy.

What is a Discretionary Fiscal Policy?

A discretionary fiscal policy is also an economic strategy that governments use. As the name suggests, it often applies for a brief period. Therefore, a discretionary policy is an ad-hoc judgment that does not follow predefined rules. It comes with a temporary change in government spending or taxes. Usually, governments use it to expand or shrink the economy for a specific period.

The discretionary fiscal policy is crucial in influencing the aggregate demand within an economy. Most governments achieve it by changing the spending levels or tax rates within a nation. These changes can be positive or adverse.

For example, a decrease in taxes will increase disposable income. Consequently, it promotes higher spending in the market. This way, it increases the aggregate demand within the economy.

On the other hand, government spending also plays a crucial role in the discretionary fiscal policy within a country. However, it has the opposite effect of that caused by taxes. Governments increase their spending on infrastructure.

It leads to a long-term increase in productivity and growth in the local demand. This way, it impacts the economic conditions positively. Consequently, it causes an increase in aggregate demand in the long run.

Discretionary fiscal policy differs from a discretionary monetary policy. The same principles apply to these as to their underlying items.

On top of that, it also goes against a commitment policy. Discretionary policies can impact the economic conditions within the economy like their underlying base. However, these occur on a case by cases basis rather than following a set of predetermined rules.

Overall, a discretionary policy is a type of government policy that impacts spending and taxes. This policy follows an ad-hoc basis and does not follow similar rules and regulations. Similarly, it plays a crucial role in influencing the aggregate demand in an economy. Governments can decrease taxes or increase spending to achieve that. The opposite of a discretionary fiscal policy is a commitment fiscal policy.

What are the advantages of Discretionary Fiscal Policy?

Discretionary fiscal policies can have a crucial role in boosting the economy. These policies can impact several areas leading to positive changes in economic conditions.

Usually, these areas help increase the aggregate demand within the economy. Some of the advantages of the discretionary fiscal policy are as follows.

Increases employment

Discretionary fiscal policy plays a crucial role in creating employment opportunities. On the other hand, it also decreases the unemployment rate within the economy. Both of these factors play a critical role in boosting the economy.

Governments can use discretionary economic policy to create job opportunities during economic recessions. Usually, they achieve it through changes in taxes and spending.

Boosts economic conditions

Discretionary fiscal policy also boosts economic conditions. This factor can be crucial in helping the economy grow during recessions or adverse economic periods. Usually, governments provide tax incentives to produce.

They, in turn, increase their production. It also leads to more job opportunities. Similarly, it helps the economy grow by raising the value of goods and services produced.

What are the disadvantages of Discretionary Fiscal Policy?

Despite having a positive impact on the economy, discretionary fiscal policy can also backfire. It can create some issues within the economy that are unfavorable.

On top of that, it can have some limitations. They impact how discretionary fiscal policy influences economic growth. Some of the disadvantages of discretionary fiscal policy include the following.

Requires time

One of the most critical limitations of discretionary fiscal policy is the time required to see its impact. Usually, governments use this policy and wait for it to create positive economic growth.

However, the time to implement it may differ significantly from when it takes effect. It may cause some issues for the economy in the meanwhile as well.

Can impact demand adversely?

Discretionary fiscal policy can grow the economy. However, governments can also use it to decrease the aggregate demand.

Practically, it is not favorable to do so. The concept still allows the use of discretionary fiscal policy to achieve that. Governments may do so by increasing taxes or decreasing spending. Therefore, discretionary economic policy can have a negative side.

Not practical to decrease spending

Governments can decrease their spending through discretionary fiscal policy. However, it is not practical to do so. On top of that, this strategy requires significant time and effort to plan and coordinate properly.

If governments fail to do so, they can experience critical issues within the economy. Although decreasing spending occurs rarely, it is still one of the disadvantages of discretionary fiscal policy.

Conclusion

A fiscal policy is a strategy to influence economic conditions within an economy. Usually, it impacts two areas, taxes and spending. One of its types includes discretionary fiscal policy.

This policy involves changing tax rates or spending levels. Usually, governments do so to stimulate economic growth. This policy can have several advantages and disadvantages, as listed above.