Expansionary and Contractionary Fiscal Policy usually means a new law. But part of the budget responds to the business cycle on its own, through Progressive, Regressive and Proportional Taxes and programs already on the books.
Key idea
Automatic stabilizers are parts of existing tax and spending law that cushion the economy without any new decision: progressive income taxes, unemployment insurance, and programs such as food assistance (SNAP) and Medicaid. In a recession they push the budget toward a deficit; in a boom, toward a surplus. Discretionary fiscal policy is a new law passed on purpose.
Why it works
When incomes fall in a recession, people slip into lower brackets and pay less tax, so disposable income falls by less than income. Laid-off workers collect unemployment insurance, and more families qualify for food assistance. Both keep spending from falling as far as it would have. In a boom the reverse happens: tax collections rise faster than incomes and fewer people need benefits, which cools spending a little. No vote is needed, so there is no delay.
A worked example
Worked example: The budget in a recession
Before a recession, a government collects \$3,200 billion and spends \$3,800 billion. In the recession, with no new laws, revenue falls \$150 billion and benefit spending rises \$80 billion. What is the new deficit?
- Old deficit: $3{,}800 - 3{,}200 = 600$.
- New: spending $3{,}880$, revenue $3{,}050$; deficit $= 830$ billion dollars.
- The automatic stabilizers added \$230 billion to the deficit, money that kept households spending.
Answer: \$830 billion
Automatic stabilizers do not end a recession on their own; they soften it, and they work in both directions without anyone having to predict the business cycle. That is one reason the budget deficit always grows in recessions, even before lawmakers act.
Common mistake
Calling any recession-fighting spending an automatic stabilizer, including new laws passed after a recession starts. Those are discretionary policy. Check: if it needed a vote after the downturn began, it is discretionary.