The Government Sector and Fiscal Policies

The government can employ discretionary fiscal policies to ease unemployment and inflation problems. Discretionary fiscal policies involve adjustments in government purchase, tax, and transfer payment programs.

In choosing the specific discretionary fiscal policy instrument to be used in a particular situation, matters such as the strength of the instrument, the lags it involves, the precise area of expenditures it affects, and whether it affects structural unemployment may be important. 

Even if the government does not employ discretionary fiscal policies to counter impacts of reductions in private demand on aggregate output, income, and employment, such impacts are diminished to some extent by the built-in fiscal policy effects which arise from the dependencies of taxes and transfer payments on income and employment levels.

A government which balances its full-employment budget is accepting the benefits of built-in fiscal policies during recessions but rejecting the use of discretionary fiscal policies as instruments to counter declines in private demand. A government which balances its budget regardless of the state of the economy is rejecting the benefits provided by built-in fiscal policies during recessions as well. It applies discretionary fiscal restraint as the economy moves into recession, worsening the recession.