Difference between Automatic Stabilizers and Discretionary Policy

DifferencesFinanceGovernments & Policies

During times of economic instability, governments may be forced to take drastic actions. It's possible that to fund certain programs, the government may need to make changes to the country's fiscal policy in areas like taxes. The rules often affect customers' ability to spend, which has repercussions for the economy.

Governments may take several economic policies, including automatic stabilizers and discretionary policies. You'll have a better handle on the economy and be able to make more educated financial decisions if you're familiar with these policies. Here, we'll compare and contrast automatic stabilizers with arbitrary government action to see which is better suited for a given economic situation.

What are Automatic Stabilizers?

It is the goal of this kind of fiscal policy to mitigate the impacts of economic cycles without resorting to supplemental authorization from policymakers or the government but rather by making use of the economy's normal operations.

Due to their independence from external stimuli, automatic stabilizers have been given this moniker. Some popular automatic stabilizers are income taxes on individuals, transfer systems like welfare and unemployment insurance, and progressive graduated corporate tax schemes. Another form of automatic stabilizer is the introduction of a progressive taxation structure, in which the share of a person's income is withheld as taxation grows in tandem with the person's income level. The overall sum declines when individual incomes fall due to factors like failed investments, job losses, or a recession.

Keynesian economics favors the employment of automatic stabilizers for the avoidance of economic downturns and slumps.

These measures can be used not just to counteract recessions and other adverse economic shocks but also to control inflation or cool down an overheated economy. These measures increase the economy's tax burden when revenues are high. They inject the money back into the economy through tax refunds or government spending when earnings are low and economic activity is slow.

What is Discretionary Policy?

The government may make changes to taxation or spending with this new economic strategy, to preserve economic stability. Instead of following a predetermined set of rules, it is decided by the policymakers on the spot based on their best judgment.

The discretionary policy makes use of the following two tools −

  • The Tax Code − Import duties, wages, and corporate profits are all subject to the regulations outlined in this document.

  • The Budget Process − Budget planning involves deciding how the money will be spent.

The following are examples of discretionary policy types −

  • Expansionary fiscal policy − To stimulate economic growth, governments often adopt expansionary fiscal policies by cutting tax revenue and boosting spending. It creates jobs, which boosts household incomes, which stimulates spending and eventually helps the economy grow. When taxes are cut, people have more disposable income, which they may use toward other needs. Product demand rises, as a result, helping to drive economic development. As a means to spur faster economic growth, the government might choose to lower both taxes and spending.

In contrast, a budget deficit may emerge if the government spends more than it collects in taxes and other revenues.

  • Contractionary fiscal policy − Contractionary fiscal policy refers to measures taken by the government to diminish the size of the economy, such as increasing taxes or decreasing spending. This tactic slows economic expansion since fewer wages reach employees and freelancers.

The discretionary fiscal policy has come under fire for the following reasons −

  • The effects of a policy on an economy don't become clear for quite some time after it's implemented.

  • Policy measures that reduce spending are notoriously difficult for governments to implement. This causes spending to rise while tax revenue falls.

  • Budget cuts make implementation difficult since key economic sectors may not survive.

  • Expenditures tend to rise in tandem with income, so if you raise your income, you can see a worsening of the trade imbalance.

  • If the government borrows too much money, businesses may be less inclined to make new investments.

Differences: Automatic Stabilizers and Discretionary Policy

Both of these programs have the goal of stabilizing economies during times of volatility. The following table highlights the major differences between Automatic Stabilizers and Discretionary Policy −

Characteristics Automatic Stabilizers Discretionary Policy
Definition The term "automatic stabilizers" refers to a type of fiscal policy that, as opposed to requiring extra authorization from policymakers or the government, seeks to balance swings in an economy through the usual operations of financial institutions. Changes in economic policy, such as those involving taxes or expenditures by the government, that are made at the discretion of policymakers are examples of discretionary policies.
Authorization There is no requirement for further authorization from policymakers or the government when using automatic stabilizers. In contrast to being governed by set guidelines, the discretionary policy is decided upon by the policymakers based on their best judgment at the time.
Timeframe Automatic stabilizers react instantly if there is a shift in the economic climate. Both the actual execution of the policy and the subsequent repercussions on the economy requires a considerable amount of time when it comes to discretionary policies.
Limitations The use of automatic stabilizers is restricted to the management of aggregate demand in a country. A discretionary policy is one that focuses on other parts of an economy.

Conclusion

The term "automatic stabilizers" is used to describe a subset of fiscal policy that, rather than requiring special authorization from policymakers or the government, works to smooth out economic fluctuations by adjusting the way financial institutions behave in their normal course of business. However, the word "discretionary policy" is used to describe a change in taxes or government spending implemented to stabilize the economy. Instead of following a predetermined set of rules, it is decided by the policymakers on the spot based on their best judgment. While the timelines for each plan's execution may differ, they both aim to reduce economic uncertainty.

raja
Updated on 30-Nov-2022 12:45:38

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