Question

using examples explain how discretionary fiscal policy and automatic stabilizers work during periods of recession or inflation in the economy

Answer 1

Answer:

discretionary fiscal policy: when government changes it taxation and expenditures to control the economic fluctuations it is said to be discretionary fiscal policy. to control the situation of inflation or recession in the economy government increases or decreases its taxation and spending. expansionary and contractionary fiscal policies are its two types of discretionary fiscal policy.

discretionary policy during recession or inflation in the economy:

recession is a period when economic activities are low which leads to unemployment and decreases money supply with people due to which there is low aggregate demand, less investment and the GDP growth is also declining. when economy faces recession government adopts expansionary fiscal policy under which government reduces tax rates and increases its expenditures.

example: if economy is going through recession the decrease in tax rates and increase in spending by government will lead to increase in the money supply in the economy, the aggregate demand will increase as money with people will increase due to low tax rates, aggregate demand will increase which will lead to increase in production and the employment, investments will also increase which will further increase the economic activities and the GDP will increase.

during inflation the price level increases and the value of money decreases which affects the economy adversely the money supply increases in the economy so to control the inflation government adopts contractionary fiscal policy under which they reduces spending and increases tax rates.

example: during inflation government will increase tax rate and will decrease spending which will reduce the aggregate demand as money with people will decrease due to high taxation and the decrease in government spending will decrease the economic activities which will lead to decrease in the money supply in the economy.

  

automatic stabilizers: when the economy stabilizes automatically through its various policies without government intervention it is known as automatic stabilizer.

example: during inflation the price level will be high and the value of money will decrease so people will decrease their expenditures which will decrease the aggregate demand which will decrease the production and it will lead to reduction in the employment rates and wages which will further decrease the supply of money in the economy and with decrease in money supply the inflation will also decrease and economy will stabilize.

during recession there is high unemployment and low economic activities also the tax rates are low so people works more to earn high income as they have to pay less taxes which reduces unemployment in the economy, the economic activities increases which leads to increase in aggregate demand and production it further leads to economy towards growth and stabilizes the economy.