econ U4 AOS1.2 Flashcards
AD formula
- think in relation to AD policies
AD = C + I + G + (X-M)
2 AD policies + brief description
budgetary policy - govt revenue & expenses
monetary policy - manipulation of interest rates by RBA
budgetary & monetary policies work in diff ways to smooth out the level of AD & the business cycle to prevent booms & busts
- if AD is too high these policies will slow it down & vice versa
describe budgetary policy
- importance
- how it stabilises the business cycle
an AD strategy that is directed by the treasurer & involves estimates of changes in the level & composition of budget receipts [revenue] and budget outlays [expenses] for the year ahead to help promote economic stability
contraction
contraction = economy is slowing down therefore, bad for living standards
fix:
- increase gov spending = increase AD
- cut interest rates & taxes
expansion = too much economic activity, tight labour market & high inflation
monetary policy:
- raise interest rates to slow spending & decrease AD
budgetary policy
- increase taxes & decrease gov spending `
sources of govt revenue
Direct tax: 70% of all govt budget
- income
- corporate
- medicare levy
Indirect tax: 25% of all govt budget
- GST
- Excise taxes
- Tariffs
Non tax revenue:
- sale of gov assets or revenue from gov businesses
- interest
types of tax scheme
progressive tax rate
- personal taxes
- means the more an individual earns the higher tax rate they will pay on their income
regressive tax
- GST; flat tax that acts regressively bc those on lower income end up paying more gst as a percentage of their income bc a higher proportion of their spending goes on items w gst attached
- tax rises as a percentage of ones income as income falls
proportional tax
- business tax where regardless of revenue that all pay the same tax rate
examples of govt outlays
- welfare; centrelink
- health
- education
- defence
types of govt spending
G1 current spending
- day to day (operational spending) the cost of running the govt
–> welfare payments, maintenance & cleaning
G2 capital spending
- govt investment into physical assets
–> new schools, new roads, new metro tunnels
Transfer payments (redistribution) [does not make up any part of AD formula only impacts AD indirectly]
- one way payments not in exchange for anything
–> aged pension, youth allowance [centrelink]
what is underlying cash balance [UCB]?
underlying cash balance [UCB]
- key fiscal measure used to assess the budget outcomes
ways of reporting the budget outcome
- underlying cash balance in $ terms
- proportion of gdp in % terms
headline cash outcome = unadjusted figure representing difference b/w the total value of cash receipts minus total value of cash outlays collected by the govt
receipts - outlays = headline cash surplus/deficit
underlying cash outcome = adjusted figure represented as headline cash outcome minus one off items from future funds & net cash flows from investments in financial assets
underlying cash balance - GDP
UCB/size of economy
budget outcomes
2022/23 - $22.2Bn surplus (contractionary)
–> E < R [money left over]
2023/24 - $9.3Bn surplus (becoming less contractionary)
–> E < R [money left over]
2024/25 $28.3Bn deficit [forecast] (expansionary)
–> E > R [in debt]
buget outcome vs debt
budget outcome - a measure of the diff b/w revenue & expenses over a period of time
debt - stock measurement at a point in time
financing a deficit
[govt]
expenses > revenue
–> can sell bonds to local investors, o/s investors, RBA
- borrow from o/s
- by selling Australian govt bonds to foreign investors. Bc in a budget deficit the international rates are lower, making repayments cheaper. however, borrowing o/s adds to NFD which may erode our international credit rating and weaken the current acc balance and debits on NPI
utilising a surplus
revenue > expenses
1. Pay off debt
- may cause interest rates to decrease, stimulating spending & offsetting the initial contractionary effects on the govt surplus economy
2. Invest; FutureFund
3. Save
relo b/w budget outcome & level of govt debt - Deficit
- expenses > revenue over a financial year
- must be financed by selling bonds
- increasing total stock of govt debt
–> increase in debt = increase in interest repayments which is an expense for the budget.
–> increasing size of future deficit
relo b/w budget outcome & level of govt debt - Surplus
- revenues > expenses over financial year
- may choose to use this surplus to:
–> pay off debt [maturing bonds], save or invest - decreasing total stock of govt debt
impact of deficit budget outcome trends from govt
anytime govt runs a deficit debt increases
- as they must sell an equal amount of bonds to finance the debt
- debt increases just at a slower rate
disadvantages of a budget deficit
- loss of a nations good credit
- increase interest payments take money away from community services
- less ready to deal w economic crisis
- increased debt is unsustainable & a burden for future gens
automatic stabilisers [cyclical component] & their influence on AD at stabilising the business cycle
automatic stabiliser - unconscious changes built into the budget that work to smooth out the business cycle without government intervention working counter cyclically
example:
In expansion
commodity prices increased; mining royalties increased
unemployment declined thus less welfare payments meaning income tax receipts increased & vice versa
–> increases leakages out of circular flow & decreases injections into economy slowing AD & econ growth
——> In contraction it is just the vice-versa
effect of auto or discretionary changes in budget outcome & govt debt
In expansion
unemployment declined
- less welfare payments [dec G1 govt spending]
- meaning income tax receipts increased [inc govt revenue] & vice versa
–> increases leakages out of circular flow & decreases injections into economy slowing AD & econ growth
resulting in
- increased surplus for 23-24 financial year
& vice versa
could:
- increase surplus
- decrease deficit
- move from def -> surplus
automatic/discretionary stabilisers on outcome/debt
increase surplus = decrease govt debt
increase deficit = increase govt debt
reduce deficit = increase govt debt but decreasing govt debt growth rate
reduce surplus = decrease govt debt
define budget stance
relates to whether the change in budget outcome is intended to have an expansionary, neutral or contractionary impact on the level of AD and eco activity
stance of budgetary policy [BP]
not vital
- How budget is used to impact the economy
using budget to expand AD & activity = expansionary stance
using it to contract AD & activity = contractionary stance
stances & outcomes
[not vital]
if the budget is contracting the level of AD and the level of activity
- budget outcome must be in surplus or moving from deficit to surplus
- revenues are growing faster than expenses
vice-versa
outcome & stances
increased surplus = more expansionary
decreased surplus = less expansionary
increased deficit = more contractionary
decreased deficit = less contractionary
from deficit -> surplus = contractionary
from surplus -> deficit = expansionary
strengths & weaknesses of budgetary policy [govt]
strengths
1. can target areas of weakness
- by changing the composition/structure of expenses or revenues
- monetary policy cant target it impacts the entire economy
2. budget impacts the level of AD relatively quickly to monetary policy
3. can increase both AD [in short term] and AS [in long term] while monetary policy does not have AS impacts
weaknesses
1. subject to political bias rather than economics
- monetary policy is independent of politics
2. subject to financial constraints due to govt need/want to bring the budget back into surplus & reduce public debt
3. long term implementation lag
- must be voted on by both houses of parliament
- takes a long time to create the policies and pitch it
have we achieved our macroeconomic goals in 23-24 financial year
full employment NAIRU = 4-4.5% currently at 4% [achieved]
SSEG 3-3.5% currently 1.1% [not achieved -> below]
low & stable inflation 2-3% currently 3.6% [not achieved -> above target]
Monetary policy impact AD only!!!
- controlled by RBA
not vital
interest rates
reward for saving or cost of borrowing money
not vital
RBA is independent of the govt
role of RBA
- implement monetary policy
- issuing notes & coins; currency is a call on the reserve bank
- banker to the fed govt
- banker to the commercial banks
role of RBA in respect to monetary policy
to achieve the 3 macroeconomic goals:
goal of full employment
- The lowest rate of unemployment that can be achieved without running into excessive inflationary pressure. Often referred to as the NAIRU, and is currently considered to be 4.5%.
- goal of SSEG
the highest growth rate possible, consistent with strong employment growth, but without running into inflationary, environmental or external pressures. Generally considered to be within the range of 3 - 3.5% per annum. - goal of low & stable inflation
2-3% growth in inflation per annum on average over the course of an economic cycle to maintain price stability within the economy.
conventional monetary policy
[cash rate target & how that impacts interest rates]
- RBA can control the cash rate commercial banks borrow & lend to each other at
- cash rate is borrowed & lended in the “overnight money market”
- in theory banks then pass those cash rate costs over to their customers via a decreased or increased interest rates
exchanged settlement accounts
- all commercial banks must hold an acc with the RBA
- this is used to settle transactions in batches
- ES accounts must be positive at the end of the day [after all transactions have been settled]
how does the RBA target the cash rate
- the RBA intervenes in the overnight money market [OMM] to settle their ES account
- the RBA intervenes by placing a restricted cash rate in the OMM called a ‘deposit rate’ and ‘lending rate’
–> the rates of interest the banks will gain from the RBA for having money in their ES account - the ‘deposit rate’ is the rate the RBA will pay banks who have a surplus $ in their ES accounts
- the ‘lending rate’ is the rate RBA will charge banks who have a deficit $ in their ES accounts
deposit rate = cash rate target [CRT] - 0.10% [10 basis points]
lending rate = CRT + 0.25%
OMM
- supply is perfectly inelastic as the RBA controls the supply of ES balances and money in the market
- P$ = cash rate
- Q = ES balances
demand line is not infinite but plateaus at the lending & deposit rate
unconventional monetary policy
- unconventional monetary policy tools r used by the rba in conjunction with conventional monetary policy [cash rate targeting] to help achieve their 3 macroeconomic goals
- unconventional tools r mostly used in extreme situations
- conventional & unconventional always push for the same outcome
e.g. asset purchasing [quantitative easing or tightening], forward guidance, yield targeting
forward guidance
- involves the RBA providing information about the future course of interest rates and its monetary policy settings
- the RBA publishes forward guidance through its monetary policy [cash rate decision]. monetary policy statements and other media releases
23/24
24/25 budget
US $95/tonne iron ore
US $65/tonne iron ore
