Chapter 22: Discretionary changes in fiscal policy and automatic stabilizers
Discretionary fiscal changes are deliberate changes in direct and indirect taxation and govt
spending – for example a decision by the government to increase total capital spending on the
road building budget or increase the allocation of resources going direct into the NHS.
Automatic fiscal changes are changes in tax revenues and government spending arising
automatically as the economy moves through different stages of the business cycle. These
changes are also known as the automatic stabilizers of fiscal policy
Tax revenues: When the economy is expanding rapidly the amount of tax revenue
increases which takes money out of the circular flow of income and spending
Welfare spending: A growing economy means that the government does not have to
spend as much on means-tested welfare benefits such as income support and
Budget balance and the circular flow: A fast-growing economy tends to lead to a net
outflow of money from the circular flow. Conversely during a slowdown or a recession,
the government normally ends up running a larger budget deficit.
Estimates from economists at the OECD have found that the effects of the automatic stabilizers
of fiscal policy can reduce the volatility of the economic cycle by up to 20%. In other words, if
the government is prepared to allow the automatic stabilizers to work through fully, the fiscal
policy can help to curb the excessive growth of demand during a boom, but also provide an
important support for income and demand during an economic downturn.
Measuring the fiscal stance
The fiscal stance is a term that is used to describe whether fiscal policy is being used to actively
expand demand and output in the economy (a reflationary or expansionary fiscal stance) or
conversely to take demand out of the circular flow (a deflationary fiscal stance).
A neutral fiscal stance might be shown if the government runs with a balanced budget where
government spending is equal to tax revenues. Adjusting for where the economy is in the economic cycle, a neutral fiscal stance means that policy has no impact on the level of economic
A reflationary fiscal stance happens when the government is running a large deficit budget (i.e.
G>T). Loosening the fiscal stance means the government borrows money to inject funds into the
economy so as to increase the level of aggregate demand and economic activity.
A deflationary fiscal stance happens when the government runs a budget surplus (i.e. G