Fiscal Policy

Question 1

Fiscal policy is…? What instruments does it use?

Answer 1

A macroeconomic policy that can influence:

• resource allocation
• distribution of Y
• fluctuations in the IBC

Instruments:

• Government expenditure
• Taxation

Question 2

What is the budget?

Answer 2

Tool used by govt for fiscal policy
Shows the govt’s planned expenditure and revenue for the next financial year (e.g. direct tax, GST and health, education etc.)

Question 3

What are the three possible budget outcomes?

Answer 3

1. Surplus (T>GS)

2. Deficit (T

Question 4

Outline the TWO main measures of the budget outcome

Answer 4

• Fiscal outcome: uses the accrual accounting method (measures expenditures and revenues when they are incurred)
• Underlying cash outcome: calculated using the cash accounting method (records revenues and expenditures when the money is collected or spent) - best indicator of ST impact of FS on EG

Question 5

Changes in the budget outcome reflect…

Answer 5

• Changing economic conditions - Non-discretionary changes (cyclical)
• Changes in govt policy - Discretionary changes (structural)

Question 6

What do discretionary changes involve?

Answer 6

• Deliberate changes to fiscal policy e.g. reducing GS or changing T rates (influence the structural component of the budget outcome)

Question 7

What do non-discretionary changes involve?

Answer 7

• Caused by changes in the level of economic activity (influence the cyclical component of the budget outcome)

Question 8

What are automatic stabilisers?

Answer 8

Policy instruments in the budget that counterbalance economic activity (counter cyclical role) e.g. boom = decrease EA, recession = increase EA

Question 9

Identify the two main automatic stabilisers

Answer 9

• Unemployment benefits

- Progressive tax system

Question 10

Describe the features of the automatic stabiliser of unemployment benefits

Answer 10

Recession > fall in EA > Rise in UE > greater GS on UE benefits

Thus, decline in EA > increase in GS

Question 11

Describe the features of the progressive tax system as an automatic stabiliser

Answer 11

People on higher Y pay proportionately more Y tax than those on a lower Y

Boom > Job opps increase > Y rise > workers move into higher Y tax brackets > increase in T and Govt revenue

Question 12

How does fiscal policy influence resource use

Answer 12

FP may directly affect resource use through GS in a specific area of the economy
- Govts can use specific taxing and spending policies to discourage consumption of products e.g. high tax on tobacco products

Question 13

How does fiscal policy influence income distribution?

Answer 13

Progressive tax system: creates more equal Y distribution

• Increasing GS on welfare payments or community services reduce Y inequality because they have a greater proportional benefit for lower Y earners

Question 14

How does fiscal policy influence economic activity?

Answer 14

The stance of the budget has a large impact on EA:

• Expansionary: increases EA by reducing T and/or increasing GS > creates smaller surplus or larger deficit > stimulates AD and EG
• Contractionary: decrease in EA by increasing T and/or decreasing GS > smaller deficit or larger surplus > dampens AD and EG

Question 15

Identify the methods of financing deficits

Answer 15

Acronym: CBBBS

• borrowing from private sector
• crowding out
• borrowing from OS
• Borrowing from RBA
• Selling assets

Question 16

Describe the private sector method of financing a deficit

Answer 16

Govt sells Treasury bonds to PS that attract $ needed to finance deficit > Lenders offer their rate of interest > Govt collects amount of $ starting at lowest IR until they can be certain they have financed their deficit

Question 17

Describe the crowding out method

Answer 17

Where GS is financed through borrowing from PS > puts upward pressure on IR > reduction in PS spending and investment - crowding out the PS investors who prefer to lend money to govt

Question 18

Describe the ‘borrowing from overseas’ method

Answer 18

Govt may borrow from OS financial markets to reduce crowding out effect while still stimulating growth - in OS currencies this is less expensive
- BUT adds to Australia’s foreign debt > recorded as debit on NPY

Question 19

Describe the RBA monetary financing method

Answer 19

Govt may borrow from RBA to finance deficit > leads to govt printing $ to finance its spending

• Avoided to ensure they don’t increase money supply and add to inflation

Question 20

Describe the ‘selling assets’ method

Answer 20

Selling assets such as land and shares - doesn’t reduce level of fiscal deficit or underlying cash deficit because they are adjusted to reflect one off transactions like asset sales

• Govt may create headline budget surplus by selling assets

Question 21

Outline the ways the govt can use a surplus

Answer 21

• Depositing it with the RBA
• Using it to pay off public sector debt
• Placing money in a specifically established, govt owned investment fund

Question 22

Assess the LT impacts of fiscal policy on the economy

Answer 22

FP has played a smaller role in recent years as the economy has sustained a moderate rate of EG

Question 23

How does fiscal policy impact economic growth?

Answer 23

Expansionary budget > increased GS and tax cuts > accelerate EG

Contractionary budget > reduced GS or higher tax rates > reduce EG

• Govt regularly adjust FP to have a counter cyclical effect on the level of EG
• Effectiveness of FP on EG may diminish LT if the accumulation of past budget deficits has created a large level of public debt

Question 24

How does fiscal policy impact unemployment?

Answer 24

Expansionary FP > reduce UE or reduce rate of cyclical UE (in ST)
- Structural changes initiated via the budget can increase Aus I and resource allocation efficiency