Fiscal Policy Flashcards
What is the Federal Budget?
The Federal Budget, delivered in Parliament in May of each year, estimates government revenue and the cost of expenditure plans for the coming year.
What was estimated revenue, expenditure and budget balance in 2016-17?
Estimated revenue in 2016-17 was $411.3 billion.
Forecast expenditure in excess of $450.6 billion.
Expenditure is greater than revenue, so the government was expecting to run a budget deficit of $39.2 billion.
What are the major sources of revenue and expenditure?
Major source of revenue:
Individuals income tax, company tax, sales tax.
Major sources of expenditure:
Social security and welfare, health, education and defense.
What are the three possible budget outcomes?
Surplus- total revenue is greater than outlays (expenditure).
Deficit- spending exceeds revenue.
Balance- if planned revenue and expenditure are equal.
Why is it important to consider the budget in relation to the previous year’s budget outcome?
The outcome of the budget really depends NOT on its absolute value (i.e. deficit or surplus), but on its value relative to the actual outcome last year.
e.g.
Budget deficit 16/17= $39 bn
Budget deficit 17/18= $37 bn
What are exogenous factors and how might they effect the budget outcome?
Exogenous factors (events not related to budget processes such as exchange rate movements, rapid changes in the ToT, or non-economic events), may also cause the actual outcome to differ from the predicted result. More government funding could be called upon in the event of major floods, droughts, or fires. These events could not necessarily have been anticipated wen compiling Budget forecasts.
Describe the three purposes of the budget.
- Decides how revenue will be raised, and allocates funds to areas of need. Budget allocation don’t change much from year to year, because they are often determined by ongoing needs e.g. education. Funding allocation is driven partly by political progress, as the government of the day needs to support its initiatives (e.g. NBN).
- The budget redistributes income from the wealthy to the less-wealthy. The wealthy pay higher rates of income tax, and people on lower incomes receive more government support (both directly and indirectly) than those on higher incomes.
- The government can use the budget to influence the level of macroeconomic activity (i.e. stabilize fluctuations in the business cycle). Keynes adopted interventionist economic policy, meaning governments should use fiscal and monetary measures to reduce the adverse effects of business cycles.
Why did Keynes argue that a balanced budget could actually destabilize the economy?
Keynes argued that the balanced budget policy could actually destabilize the economy because government expenditure was tied to revenue. In a trough, when revenue falls, a budget balance would result in a fall in government expenditure- just the opposite of what the economy needed to boost the level of spending and output.
How can a budget deficit be financed?
A budget deficit must be financed because a debt has been created which must be paid off in the future.
Three ways this can be done:
-Selling government bonds
-Borrowing from the central bank/Reserve Bank
-Borrowing from overseas
How can the government finance a budget deficit by selling government bonds?
Government bonds are financial instruments which raise funds for its issuer (government). They are very safe. Consumers use surplus cash/savings to buy government bonds and earn interest. In selling bonds, the government raises money to finance its budget deficit. A large bond issue may cause an increase in interest rates across the market because government borrowing creates higher demand for credit in financial markets.
Explain the problem of crowing out.
‘Crowing out’ is the increase in interest rates due to higher demand for credit. This competition (crowding out) occurs because the private sector is crowded out because of government borrowing. This causes a paradox -> government borrows to increase economic activity but increased interest rates would dampen consumption.
What is the main advantage of the gov borrowing from the private sector?
The main advantage of the government borrowing from the private sector is that it does not increase the MONEY SUPPLY. The public initially withdraws money from the banking system to pay for purchases and securities. When the government spends the borrowed funds the net effect is nil.
What is the likely consequence of the government borrowing from the RBA to finance the deficit?
When borrowing from the RBA it is injecting new money into the economy. This has a desired expansionary effect on the economy but will increase the money supply and is likely to have an inflationary effect.
What is the likely consequence of the government borrowing from overseas to finance the deficit?
Borrowing from overseas does NOT increase the money supply under Australia’s system of a floating exchange rate, BUT the exchange rate will DEPRECIATE due to the inflow of money capital (other things being equal). Therefore, exports will be less competitive and imports will increase. This is counter effective to Budget deficit objectives.
Explain the various ways the government can use the budget surplus funds.
- The surplus could be used to retire (pay off) government debt build up by past deficits, held over to funds future expenditure, or returned to taxpayers as tax cuts.
- All three happened in the mid 2000’s, when Australia was one of the few countries in the world with no public debt.
- Australia still has comparatively low debt even after the spending stimuli associated with the global economic slowdown.
Explain the problem of crowding in.
There are a number of secondary effects that might counteract the original intentions of the surplus.
Retiring debt, for example, means that bond holders are repaid the capital value of their bonds, giving them extra spending power.
This has been called ‘crowding in’. Lower public debt may also raise a question about ‘intergenerational equity’- the idea that the coasts of infrastructure built today should be shared between today’s taxpayers and those who will also benefit from those facilities in the future.
That is, future taxpayers are ‘free-riding’ on current taxpayers if public debt is relatively low.
What is the difference between the structural and cyclical component of a budget?
The cyclical component of the budget refers to the way in which the government revenue and expenditure is affected by the current state of the economy and the business cycle.
The structural component refers to the DELIBERATE decisions made by the government when planning expenditure and revenue and deciding whether the budget will be in deficit or surplus.
What does the term ‘structural balance’ mean in terms of the budget balance?
Structural balance is an estimate of the budget balance, excluding the cyclical factors. This is important because it reveals how governments change the revenue and spending settings to achieve longer term macroeconomic policy objectives.
How do automatic stabilisers work during a trough phase?
When the economy enters the trough phase of the cycle, tax revenue falls, so the budget balance moves towards deficit (or an increasing deficit).
How do automatic stabilisers work during a boom?
When the economy is stronger, tax revenue rises and welfare payment fall, so the budget balance becomes increasingly positive.
As a result, income taxes and transfer payments act like an economic shock absorber. They reduce the level of aggregate spending in a boom, and increase it in a trough.
They also impact upon the budget outcome- a budget deficit will automatically increase as the economy contracts, and automatically decreases as the economy expands.
With the use of a diagram, explain how automatic stabilisers work.
Tax revenue rises as GDP rises, as shown by the positively sloped line. The transfer payments line is negatively sloped, because claims on welfare fall as economic activity rises.
If we start at the Budget balance point and the economy slow, tax revenue will fall and transfer payment rise pushing the budget in to deficit and stabilizing the economy to some extent.
Alternatively, if we start at the Budget balance point and the economy expands, tax revenue rises and transfer payment fall- automatically pushing the budget towards surplus and stabilizing the economy by reducing aggregate spending power.
Define discretionary fiscal policy.
The deliberate changes to expenditure and revenue that the government makes in the budget to stabilize the economy.
Explain how discretionary fiscal policy works.
- In a period of low economic activity, it is appropriate to run an expansionary budget in order to stimulate spending.
- In a period of higher economic activity, it would be appropriate for the government to plan a budget surplus to reduce the growth in spending and in the economy.
- If the government thought economic conditions were close to the natural rate of employment with inflation in the 2-3% range, it might adopt a neutral budget stance.
What are some ways the government might stimulate household and business spending?
- Reducing income tax to increase household purchasing power.
- Cutting corporate tax (tax on company profits) to stimulate business spending on infrastructure, such as transport and communications projects.