Chapter 21, Problem 1SQP

To determine

Discretionary fiscal policy impact on recession and inflation.

Explanation of Solution

The discretionary fiscal policy refers to the fiscal policy of the government that is used according to the need of the government. There are two types of fiscal policies that the government can make use according to its discretion. They are the expansionary fiscal policy and contractionary fiscal policy according to the recession and inflation, respectively.

The expansionary fiscal policy includes the measures that increase the money supply in the economy. The expansionary fiscal policy is implemented when the economy is faces a recession. When the policy is implemented, the tax rate will decrease in the economy with increased government spending in the economy. This means that the aggregate demand in the economy will increase and it will shift the AD to the right. As a result, there will be increase in the real GDP of the economy, which will release the economy from the recessionary gap.

The contractionary fiscal policy is introduced at the discretion of the government when the economy moves through the inflation. The contractionary policy includes the increased tax rates as well as decreased government spending. It will decrease the supply of money in the economy, which will result in the leftward shift in the AD curve reducing the inflation and reverting the economy back to equilibrium. Thus, through these ways, the discretionary fiscal policy helps to avoid the recession and inflation in the economy.

Economics Concept Introduction

Fiscal policy:  The fiscal policy is the policy of the government regarding the taxation and government spending in order to monitor and regulate the economy of a nation.