Discretionary policy refers to economic policies actively managed and decided by the government or monetary authorities, not set automatically by existing laws or regulations. Unlike automatic stabilizers, which function without direct intervention (e.g., unemployment insurance), discretionary policies require deliberate action, such as changing interest rates or altering tax laws.
Financial Authorities and Discretionary Policy
Role of the Federal Reserve
The Federal Reserve Board (often referred to simply as the Fed) utilizes various discretionary tools to manage the economy. These tools include:
- Money Supply Adjustments: The Fed can either increase or decrease the money supply through open market operations, such as buying or selling government securities.
- Discount Rate: The Fed sets the discount rate, which influences other interest rates within the economy, affecting borrowing, spending, and investment.
Types of Discretionary Policy
Monetary Policy
Monetary policy involves managing the economy through changes in the money supply and interest rates. Key instruments include:
- Open Market Operations: Buying or selling government securities to expand or contract the amount of money in the banking system.
- Reserve Requirements: Adjusting the amount of funds banks must hold in reserve.
- Discount Rate: Changing the rate at which banks can borrow from the Federal Reserve.
Fiscal Policy
Fiscal policy revolves around government spending and taxation decisions, aiming to influence economic conditions. Tools include:
- Tax Cuts or Increases: Adjusting the tax burden on individuals and businesses.
- Public Spending Programs: Implementing or retracting spending initiatives to stimulate or cool the economy.
Historical Context and Application
Discretionary policies have played significant roles in various economic contexts. For example, during the Great Depression, the U.S. government implemented substantial fiscal policies (New Deal programs) to revive the economy. Similarly, recent recessions have seen central banks worldwide implement aggressive monetary policies, such as quantitative easing.
Comparisons and Special Considerations
- Discretionary vs. Automatic Stabilizers: Discretionary policies require active government decisions, while automatic stabilizers work without direct intervention.
- Lag Effects: Discretionary policies often suffer from recognition, implementation, and response lags, limiting their immediate effectiveness.
Related Terms
- Automatic Stabilizers: Economic policies and programs designed to offset fluctuations without active government involvement, such as social security and unemployment benefits.
- Quantitative Easing (QE): A monetary policy wherein a central bank buys government securities to increase the money supply and encourage lending and investment.
- Fiscal Stimulus: Government measures, typically increased public spending and tax cuts, aimed at stimulating economic activity.
FAQs
Q: What is the main goal of discretionary policy? A1: The main goal is to influence economic conditions actively to achieve objectives such as controlling inflation, reducing unemployment, and fostering economic growth.
Q: How does the Federal Reserve’s adjustment of the discount rate affect the economy? A2: Changes in the discount rate influence other interest rates, impacting borrowing, spending, and overall economic activity.
Q: What are the limitations of discretionary policies? A3: These policies can suffer from lag effects, political constraints, and unintended consequences.
References
- Mishkin, Frederic S. The Economics of Money, Banking, and Financial Markets. Pearson, 2018.
- Bernanke, Ben S. The Federal Reserve and the Financial Crisis. Princeton University Press, 2013.
- Keynes, John Maynard. The General Theory of Employment, Interest, and Money. Harcourt, Brace and Company, 1936.
Summary
Discretionary policies, encompassing both monetary and fiscal measures, allow governments and central banks to actively manage economic conditions. They are crucial during economic downturns and periods of excessive growth, offering flexibility to address specific economic challenges. Their effectiveness, however, is often tempered by various implementation lags and external factors. Understanding these policies is paramount for comprehending modern economic management and intervention strategies.
