4.1 - Aggregate Demand Policies and Domestic Economic Stability Flashcards
1
Q
Budgetary (Fiscal) Policy
A
- The manipulation of the level and composition of Federal Government revenues and expenses, in order assist in the achievement of economic and social goals
- Main aggregate demand management instrument
2
Q
Government Revenue
A
- Incoming money that pays for budget outlays
- Includes direct taxes, indirect taxes, revenue from government businesses and the sale of assets
3
Q
Progressive Tax
A
- Collects proportionally more from higher income earners compared to lower income earners
- For example - income tax
4
Q
Proportional Tax
A
- Collects proportionally identical the same amount from all income earners
- For example - Medicare Levy, company tax
5
Q
Regressive Tax
A
- Collects proportionally more from lower incomes earners compared to higher income earners
- For example - Goods and Services Tax
6
Q
Direct Taxes
A
- Taxes paid directly to the government and usually paid on income
- Examples: income tax, capital gains tax, Medicare levy, witholding tax, company tax
7
Q
Indirect Taxes
A
- Usually taxes on expenditure or consumption
- Examples: excise duty on coal, petrol, tobacco and alcohol; Goods and Services Tax; Customs tariffs
8
Q
Non Tax Revenue
A
- Sale of Government assets – for example, Medibank Private in 2014
- Profits from Government businesses – for example, Australia Post
- HECS repayments
9
Q
Main Government Expenses
A
- Social security and welfare = 35%
- Health = 17%
- Education = 7%
- Defence = 6%
10
Q
Government Expenditure (G)
A
- Government Consumption Expenditure (G1)
o Goods and services that are consumed in the current budget period, and have no ongoing benefits
o For example, wages and supplies for schools and hospitals - Government Investment Expenditure (G2)
o Government capital expenditure designed to increase the productive capacity of the economy
o Includes infrastructure projects - Unemployment benefits are not included in government expenditure as they are transfer payments, and will eventually be included in C or I
11
Q
Budget Outcomes
A
- Balanced budget – when revenue = expenditure
- Budget deficit – when revenue < expenditure
- Budget surplus – when revenue > expenditure
12
Q
Headline Cash Balance
A
Total cash received by the Government minus total cash paid
13
Q
Underlying Cash Balance
A
- Excludes cash flows that do not hare a direct or immediate impact on the economy
- For instance, future fund earnings and proceeds from asset sales are excluded
14
Q
Underlying Cash Balance as a Proportion of GDP
A
Shows how expansionary or contractionary the budget is, in comparison to GDP
15
Q
Fiscal Outcome
A
Total cash received by the Government minus total cash paid only over the relevant budget period
16
Q
Actual vs Estimate Budget Figures
A
- Actual budget figures are for the previous financial year
- Estimate budget figures are predictions for future financial years
17
Q
Contractionary Budgetary Stance
A
- Occurs when the budget is in surplus
- Reduced government expenditure (G) → lower aggregate demand
- Reduced transfer payments → reduced C + I → lower aggregate demand
18
Q
Expansionary Budgetary Stance
A
- Occurs when the budget is in deficit
- Increased government expenditure (G) → higher aggregate demand
- Increased transfer payments → increased C + I → higher aggregate demand
19
Q
Bonds
A
- Issued by the Federal Government with a promise to pay periodic interest and repay the principle on the maturity date
- Sell bonds to - RBA, overseas investors, domestic investors
20
Q
Selling Bonds to RBA
A
- Involves the RBA purchasing bonds using assets in their vault or by printing money
- This is the most expansionary and inflationary source of funding
21
Q
Selling Bonds to Overseas Investors
A
- Will result in higher net foreign debt and a higher Current Account Deficit due to interest repayments
- Will also appreciate the AUD due to higher demand for it
22
Q
Selling Bonds to Australian Investors
A
- Will result in higher interest rates due to higher demand for money
- Will ‘crowd out’ the private sector, as there will be less funds available for consumption or investment expenditure
23
Q
Consequences of a Budget Deficit
A
- Cost of repaying bonds – may need higher tax and lower government spending to service
- ‘Crowding out’ of domestic markets
- Impact on credit rating
24
Q
Implications of a Budget Surplus
A
- Able to invest into financial markets
- Able to repay debt
- Increases credit ratings
- Able to place into funds – such as the Future Fund → can act as a buffer against future economic decline
- Reduces interest rates so increases private consumption and investment spending
25
Discretionary Stabilisers
+ Their Operation
* Deliberate changes to the composition or volume of receipts/payments
* Represents the structural component of the budget
* Includes changes to tax rates and infrastructure projects
o Decrease in growth → increased discretionary measures → increased growth and net debt
o Increase in growth → decreased discretionary measures → decreased growth and net debt
26
Automatic Stabilisers
* Automatic changes to the level of economic activity – government does not have to announce or implement changes to the budget for automatic stabilisers to work
* Operate counter-cyclically
* Represents the cyclical component of the budget
* Includes tax receipts and welfare benefits
o Decrease in growth → decreased tax receipts and increased welfare benefits → increased net debt and increased growth
o Increase in growth → increased tax receipts and decreased welfare benefits → decreased net debt and decreased growth
27
2023/24 Budet Policy:
Instant Asset Write-Off
* Allows businesses to claim up to a $20k deduction from their tax liability when they purchase new assets, equipment or machinery
* → increased willingness and ability for businesses to purchase → increased private investment expenditure → increased aggregate demand →
* Impact on SSEG: increased production → increased economic activity
* Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
* Impact on Low Inflation: increase demand inflationary pressures → increased inflation
28
2023/24 Budet Policy:
Child Care Subsidy
* Subsidises childcare for families earning up to $530k p.a.
* Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
* Impact on SSEG: increased production → increased economic activity
* Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
* Impact on Low Inflation: increase demand inflationary pressures → increased inflation
29
2023/24 Budet Policy:
Infrastructure Pipeline
* $120bn in spending on infrastructure over the next 10 years
* Increases government investment expenditure (G2) → increased aggregate demand →
* Impact on SSEG: increased production → increased economic activity
* Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
* Impact on Low Inflation: increase demand inflationary pressures → increased inflation
30
2022/23 Budet Policy:
Low and Middle Income Tax Offset
* Reduces the amount of tax payable for low and middle income earners by an additional $420 p.a. to a total of $1500
* Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
* Impact on SSEG: increased production → increased economic activity
* Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
* Impact on Low Inflation: increase demand inflationary pressures → increased inflation
31
2022/23 Budet Policy:
Fuel Excise Reduction
* Reduces the fuel excise by 50%
* Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
* Impact on SSEG: increased production → increased economic activity
* Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
* Impact on Low Inflation: increase demand inflationary pressures → increased inflation
32
2022/23 Budet Policy:
Cost of Living Payment
* $250 cash payment for eligible pensioners and welfare recipients to assist with cost of living pressures
* Increases disposable income → increased willingness and ability to purchase goods and services → increased private consumption expenditure → increased aggregate demand →
* Impact on SSEG: increased production → increased economic activity
* Impact on Full Employment: increased production → increased derived demand for labour → lower unemployment
* Impact on Low Inflation: increase demand inflationary pressures → increased inflation
33
Strengths of Budgetary Policy
* Able to target specific sectors – increase growth in low growth sectors while not causing excessive growth in other sectors
* Short time lag for automatic stabilisers to act
* Short impact lag for policies to have an effect on the economy
* Able to stimulate aggregate demand directly by increasing C, I and G
* Checks and balances prevent poorly designed policies from being implemented
* Public scrutiny increases transparency and accountability so prevents poorly designed policies from being implemented
34
Weaknesses of Budgetary Policy
* Financial restrictions – government can only introduce so many policies as they wish to prevent increasing debt or taxes
* Can undermine monetary policy
* Some discretionary stabilisers have long time lags, such as infrastructure projects
* Lack flexibility as the budget is only delivered once a year
* Implementation lag as bills take time to pass both houses of parliament and may require cooperation with state governments
* Less effective at restricting aggregate demand during a boom – government is less able to restrict disposable income of consumers
* Political hurdles – bills can be blocked by the Senate
* Political bias – policies may bander to voters or lobby groups
35
Implementation of Monetary Policy
* Target cash rate set by RBA at board meetings
* RBA manipulation of cash rate allows it to indirectly affect all other interest rates
36
Overnight Money Market
o A market in which financial institutions borrow from and lend to each other
o RBA controls the supply of cash (liquidity) in the overnight money market
37
Conventional Monetary Policy
* RBA manipulates the supply of cash in the overnight money market by buying and selling Commonwealth Government Securities
* Increase interest rates: RBA will sell securities to banks, taking cash out of circulation and reducing the supply of cash (reducing liquidity) → upward pressure on interest rates
* Decrease interest rates: RBA will buy securities from banks, putting cash into circulation and increasing the supply of cash (increasing liquidity) → downward pressure on interest rates
38
Loosening of Monetary Policy
RBA announcing a lower target cash rate → increasing liquidity
39
Tightening of Monetary Policy
RBA announcing a higher target cash rate → decreasing liquidity
40
Unconventional Monetary Policy - Foward Guidance
* RBA signals its expectations for monetary policy into the future
* Expected reduced/stable cash rates → increased willingness to borrow
* Expected increased cash rates → decreased willingness to borrow
* For example – 2020, the RBA suggested that the cash rate would not increase for at least 3 years
41
Expansionary/Accommodative Stance
Achieved through reducing the cash rate (loosening monetary policy) = <3.5%
42
More Expansionary/Accommodative Stance
Growth is able to continue to increase without a change to interest rates as the rates are low enough already to stimulate growth
43
Contractionary/Restrictive Stance
Achieved through increasing the cash rate (tightening monetary policy) = >3.5%
44
More Contractionary/Restrictive Stance
Growth is able to continue to decrease without a change to interest rates as the rates are high enough already to slow growth
45
Neutral Stance
When the cash rate is neither working to stimulate nor contract the economy = 3.5%
46
Transmission Mechanism 1:
Savings and Investment
* Interest rates change the incentives for savings and investment
* Increase in the cash rate:
o Consumers are more likely to save → reduced C → decreased AD
o Consumers and businesses are less likely to borrow → reduced C + I → decreased AD
* Decrease in the cash rate:
o Consumers are less likely to save → increased C → increased AD
o Consumers and businesses are more likely to borrow → increased C + I → increased AD
47
Transmission Mechanism 2:
Cash Flow
* Cash flow: cash available for purpose other than paying interest on loans
* Increase in the cash rate → increased proportion of income to pay interest → decreased cash flow → decreased C + I → decreased AD
* Decrease in the cash rate → decreased proportion of income to pay interest → increased cash flow → increased C + I → increased AD
48
Transmission Mechanism 3:
Exchange Rate
* Higher cash rate → foreign investors more willing to save in Australia due to higher returns → increased demand for AUD → appreciation of AUD → decreased international competitiveness → decreased net exports → decreased AD
* Lower cash rate → foreign investors less willing to save in Australia due to lower returns → decreased demand for AUD → depreciation of AUD → increased international competitiveness → increased net exports → increased AD
49
Transmission Mechanism 4:
Asset Prices
* Higher interest rates → lower demand for assets due to reduced willingness to borrow → decreased value of assets → asset owners become less confident to spend → decreased C → decreased AD
* Lower interest rates → higher demand for assets due to increased willingness to borrow → increased value of assets → asset owners become more confident to spend → increased C → increased AD
50
Goals of RBA
* Stability of the currency
* Maintenance of full employment
* Economic prosperity and welfare
51
Role of RBA
* RBA is responsible for monetary policy
* Set the cash rate, which influences other interest rates, to control economic activity, employment and inflation
* Uses underlying inflation as the key statistic to forecast future inflation
52
Implementation of Monetary Policy
* Target cash rate set by RBA at board meetings
* RBA manipulation of cash rate allows it to indirectly affect all other interest rates
53
Conventional Monetary Policy
* Overnight money market:
o A market in which financial institutions borrow from and lend to each other
o RBA controls the supply of cash (liquidity) in the overnight money market
* RBA manipulates the supply of cash in the overnight money market by buying and selling Commonwealth Government Securities
* Increase interest rates: RBA will sell securities to financial institutions, taking cash out of circulation and reducing the supply of cash (reducing liquidity) → upward pressure on interest rates
* Decrease interest rates: RBA will buy securities from financial institutions, putting cash into circulation and increasing the supply of cash (increasing liquidity) → downward pressure on interest rates
54
Loosening of Monetary Policy
RBA announcing a lower target cash rate → increasing liquidity
55
Tightening of Monetary Policy
RBA announcing a higher target cash rate → decreasing liquidity
56
Unconventional Monetary Policy - Forward Guidance
* RBA signals its expectations for monetary policy into the future
* Expected reduced/stable cash rates → increased willingness to borrow
* Expected increased cash rates → decreased willingness to borrow
* For example – 2020, the RBA suggested that the cash rate would not increase for at least 3 years
57
Stance of Monetary Policy
* Expansionary/accommodative: achieved through reducing the cash rate (loosening monetary policy) = <3.5%
o More accommodative: growth is able to continue to increase without a change to interest rates as the rates are low enough already to stimulate growth
* Contractionary/restrictive: achieved through increasing the cash rate (tightening monetary policy) = >3.5%
o More contractionary: growth is able to continue to decrease without a change to interest rates as the rates are high enough already to slow growth
* Neutral: when the cash rate is neither working to stimulate nor contract the economy = 3.5%
58
Transmission Mechanism 1:
Savings and Investment Channel
* Interest rates change the incentives for savings and investment
* Increase in the cash rate:
o Consumers are more likely to save → reduced C → decreased AD
o Consumers and businesses are less likely to borrow → reduced C + I → decreased AD
* Decrease in the cash rate:
o Consumers are less likely to save → increased C → increased AD
o Consumers and businesses are more likely to borrow → increased C + I → increased AD
59
Transmission Mechanism 2:
Cash Flow
* Cash flow: cash available for purpose other than paying interest on loans
* Increase in the cash rate → increased proportion of income to pay interest → decreased cash flow → decreased C + I → decreased AD
* Decrease in the cash rate → decreased proportion of income to pay interest → increased cash flow → increased C + I → increased AD
60
Transmission Mechanism 3:
Exchange Rates
* Higher cash rate → foreign investors more willing to save in Australia due to higher returns → increased demand for AUD → appreciation of AUD → decreased international competitiveness → decreased net exports → decreased AD
* Lower cash rate → foreign investors less willing to save in Australia due to lower returns → decreased demand for AUD → depreciation of AUD → increased international competitiveness → increased net exports → increased AD
61
Transmission Mechanism 4:
Asset Prices
* Higher interest rates → lower demand for assets due to reduced willingness to borrow → decreased value of assets → asset owners become less confident to spend → decreased C → decreased AD
* Lower interest rates → higher demand for assets due to increased willingness to borrow → increased value of assets → asset owners become more confident to spend → increased C → increased AD
62
'Factors' Influencing Monetary Policy
* Trends in inflation
* Levels of national spending and confidence
* Labour market conditions
* Budgetary policy stance
* International developments
63
Strengths of Monetary Policy
* RBA independent from political bias or considerations
* Short implementation lag due to monthly board meetings
* Influences expectations of consumers, investors etc
* Effective at controlling inflation through aggregate demand
64
Weaknesses of Monetary Policy
* Imprecise/blunt instrument – cannot target certain sectors of the economy
* Long time lag – up to 2 years for impact to take full effect
* No direct control over interest rates – up to banks to determine whether to implement changes to cash rate
* Less effective at increasing AD as consumers/businesses may prefer to reduce debts than increase consumption/investment
* Cannot reduce cost inflation
* Ageing population → increased reliance on interest rates on savings to spend → decrease in interest rates to stimulate spending may have opposite effect
65
Budget Outcome and Public Debt
* Budget deficit → sell bonds → increase public debt
* Budget surplus → able to repay existing debt → decrease public debt
