Budgetary Policy (Demand Side)

Question 1

Budgetary Policy

Answer 1

Budgetary Policy is an aggregate demand measure and relates to changes in the anticipated levels and composition of government revenues and expenses for the year

Question 2

Monetary Policy

Answer 2

Monetary Policy is a branch of macro economic policy operated by the RBA and designed to regulate the level of AD and economic activity. It relies most heavily on changes in interest rates to alter the cost, availability and demand for credit. (borrowed money)

Question 3

Underlying Budget Outcome

Answer 3

Underlying budget outcome represents the headline balance after subtracting the value of once off volatile items. e.g asset sales, debt repayments and loans to state governments.

Question 4

Headline Budget Outcome

Answer 4

Headline balance refers to the difference between the total cash value of budget receipts minus the cash value of total outlays from all sources, without the removal of items that are affected by one off events. e.g asset sales, debt repayments and loans to state governments.

Question 5

Bracket Creep

Answer 5

Bracket creep occurs when recipients of rising income gradually move into higher income tax brackets, which raises the tax burden.

Question 6

Policy Mix

Answer 6

Policy mix is the combination of different categories of policy (for example budgetary and monetary policy) to help promote a particular economic goal, such as low inflation.

Question 7

Automatic Stabilisers

Answer 7

Automatic stabilisers are changes in tax revenues collected and welfare outlays that are built into the budget and operate correctly in a counter cyclical way to help stabilise AD, without the treasurer deliberately changing their level or announcing new policies.

Question 8

Discretionary Stabilisers

Answer 8

Discretionary stabilisers in the budget are deliberate changes in tax rates, the tax mix and direction and composition of budget outlays specifically announced by the treasurer to steady economic activity in response to developments. e.g Abolishing, introducing or altering tax rates or altering the level of outlays on areas such as welfare, education and health.

Question 9

Budgetary Stance

Answer 9

Budget Stance refers to whether the budget is neutral, expansionary or contractionary in its impact on the level of AD and economic activity

Question 10

Direct Tax

Answer 10

Direct tax is levied as a proportion of income received by individuals or companies. e.g personal income tax (PAYG), company tax.

Question 11

Indirect Tax

Answer 11

Indirect tax is added onto the price of a good or service at the point of sale, making the item more expensive. e.g GST (goods and service tax), excise tax, non tax revenue (gov sales of g/s, petroleum royalties.)

Question 12

PAYG

Answer 12

Pay-as-you-go (PAYG) tax is a direct progressive tax levied on incomes received by individuals at marginal rates of zero percent up to 45 percent.

Question 13

Progressive Tax

Answer 13

Progressive taxes are designed to redistribute income more evenly. The tax rate increases as personal income levels increase.

Question 14

Regressive Tax

Answer 14

Regressive tax is a tax that tends to exaggerate income inequalities because low incomes are taxed at higher rates than high incomes. e.g excise taxes.

Question 15

Three Transition Mechanisms

Answer 15

• Higher interest rates slow spending ( decrease in C, I leads to a decrease in AD, decreasing demand inflation. )
• Higher interest rates push up $AUD ( due to foreign investors, decreasing both demand and cost inflation. ) -Higher interest rates depress inflationary expectations ( businesses don’t raise prices. )

Question 16

Persuasion

Answer 16

Persuasion involves the RBA influencing AD via statements that indicate future movements in the official cash rate.

Question 17

Crowding out

Answer 17

Occurs when the government adopts an expansionary fiscal policy ( to prevent a recession ) and gets its funding by borrowing from domestic banks. This creates a cash shortage and there is an increase in demand for cash in the private sector, pushing up interest rates. This undermines the RBA’s efforts in decreasing interest rates to promote a recovery.

Question 18

Dirty Float Steps

Answer 18

1. RBA wants to increase the exchange rate 2. In the foreign exchange market, the RBA becomes a net buyer of $AUD or reduces its net sales causing the dollar to appriciate. 3. Stronger $AUD will tend to increase CAD but will slow inflation, AD and employment.

Question 19

Steps in changing the cash rate

Answer 19

1, RBA announces a increase in the official cash rate. 2. RBA becomes a net seller of Government bonds and securities in the overnight money market. 3. A shortage of cash in the OMM drives up i/r 4. The higher cash rate then spreads via a “ripple effect.” The higher costs are passed on. 5. Higher I/R then impacts the economy via transition mechanisms.

Question 20

How can budgetary policy be used to achieve domestic economic stability?

Answer 20

By operating in a counter cyclical manner (due to automatic and discretionary stabilisers ) these 3 eco goals are likely to be achieved. ( business cycle smoothing. )

Question 21

How can budgetary policy be used to achieve external stability?

Answer 21

By moderating eco growth, (smoothing business cycle) the government can decrease the likelihood of spending “spilling over” into imports.

Question 22

How can budgetary policy be used to achieve equity in distribution of income?

Answer 22

The nature of income tax is that as your income increases you pay a higher percent in tax which is transferred to low income earners via welfare. This is known as the “robin hood principle”.

Question 23

Aims of monetary policy

Answer 23

Stability of the currency (low inflation), Strong and sustainable economic growth and full employment. (smoothing the business cycle)

Question 24

How can a budget deficit be financed?

Answer 24

Overseas borrowing, (appreciates $AUD and adds to NFD) borrow from the RBA, (Increases inflation, basically involves the gov printing more money) borrow from the private/public sector. (“crowding out” increases interest rates)

Question 25

Largest revenue items in the budget

Answer 25

Individual income tax, Company tax, Sales tax (GST)

Question 26

Largest expenditure in the budget

Answer 26

Social security and welfare, Health

Question 27

Fixed Incomes

Answer 27

Fixed incomes are incomes that remain relatively fixed or unchanged over time. Retired persons, for example, are usually on fixed incomes as they may receive a pension that will only change if the government decides to increase the pension.

Question 28

Clean floating (or free floating) exchange rate

Answer 28

Clean floating (or free floating) exchange rate is a situation where the exchange rate is determined at equilibrium by market forces of supple and demand for the $AUD in the absence of RBA interference in the foreign exchange market.

Question 29

Structural Budget Outcome

Answer 29

Structural budget outcome refers to the deliberate (discretionary) decisions taken by the government that impact on revenue and expenses. e.g tax cuts

Question 30

Cyclical Budget Outcome

Answer 30

Cyclical budget outcome refers to the movement in expenditure and revenue due to changes in the business cycle and the corresponding impact such movements have on the budget outcome.

Question 31

Weakness of Fiscal Policy

Answer 31

• Lag effects: Implementation and impact lag; time taken for government to act and time taken for policy measure to work
• Subject to political pressures

Question 32

Strength of Fiscal Policy

Answer 32

Budgetary policy can focus on particular areas of the economy, target key focus groups. e.g stay at home parents, housing sector

Question 33

Weakness of Monetary Policy

Answer 33

It is a very blunt policy tool and can have unintended impacts upon some areas of the economy.

Question 34

Strength of Monetary Policy

Answer 34

• Short Implementation lags

- Not subject to political pressures

Question 35

Three instruments of monetary policy

Answer 35

Interest rate changes, dirty float intervention or persuasion

Question 36

Cost of credit transition mechanism

Answer 36

The cost of credit transition mechanism is the transition mechanism through which changes in interest rates affect the incentives to save or invest, and therefore the wider economy.

Question 37

Cash flow transition mechanism

Answer 37

The cash flow channel is the mechanism which changes in the cash rate affect loan repayments for those with existing loans.

Question 38

Asset price affect transition mechanism

Answer 38

Changes in interest rates may affect the value of assets and how wealthy people feel

Question 39

Excise tax

Answer 39

Four annual 12.5% increases in tobacco excise and equivalent customs duty, with the first increase to take even on September 1st 2017