Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Always repay your debts

This rule may sound obvious, but it’s important. Governments often borrow money by issuing bonds. Eventually the holders of these bonds turn up expecting to be repaid for the money they lent. The government can always refuse to pay – called defaulting. Bondholders can’t do much to force governments to repay their debts. Despite this ability to default, most governments attempt to commit to a rule of always repaying their debts even if defaulting looks immediately attractive.

Exercising your discretion

With discretionary policy, policy makers can exercise their own judgement as and when they consider it necessary. This includes the freedom to change their minds and take an action they said previously they wouldn’t.

Now, if you promise yourself to help your diet by ordering a skinny latte for lunch and then you change your mind and eat biscotti with your frappacino, nothing suffers except your waistline. But when policy makers choose to use their discretion when making macroeconomic decisions, the stakes can be huge.

In this section we explain different examples of discretionary policy. Even though there are certainly problems with discretion, discretionary policy is still widely used throughout the world – especially discretionary fiscal policy.

We cover three examples of discretionary policy, comparing and contrasting them to the three policy rules in the preceding section.

Discretionary fiscal policy

When politicians are free to decide how much the government should spend and raise in taxes, economists say that fiscal policy is conducted by discretion (in contrast to the balanced budget rule we discuss in the preceding section, which is a type of fiscal policy rule).

The government may decide to spend more every year than it raises in taxes – that is, run a deficit. Or it may decide to spend less every year than it raises in taxes – that is, run a surplus. (With politicians, the former is much more likely than the latter!) Or it can decide anything in-between. Contrast this with the balanced budget rule, which says that the government must balance

its books.

In most places in the world, fiscal policy is conducted by discretion.