Fiscal Policy: Concepts

Question 1

Why is the budget considered an automatic stabiliser for the economy?

Answer 1

In an upturn or boom, higher profits, incomes and employment will automatically lead to higher tax revenue and lower welfare spending. This will reduce AD, helping to stabilise the business cycle.

The opposite will happen in a downturn / recession

Question 2

What is the crowding out effect?

Answer 2

Borrowing by the government increases the demand for loans, meaning that lenders charge higher interest rates to firms in the economy (which would slow down the economy)

Also, any funds lent to the government are not invested elsewhere in the economy, so investment (part of AD) will be lower than it otherwise would have been

Question 3

Why is a budget deficit risky for external stability?

Answer 3

1) Increased foreign debt to fund the deficit
2) Twin deficit theory (a budget deficit will worsen the current account): the interest repayments will worsen NPI, and the increased growth that the budget deficit stimulates will cause higher incomes and import spending, worsening the BOGS

Question 4

What is the disadvantage of borrowing from the private sector to fund a budget deficit?

Answer 4

The crowding out effect

Question 5

What is the disadvantage of borrowing from the overseas to fund a budget deficit?

Answer 5

1) Worsens NFD and NPI

2) Slight upward pressure on the AUD (due to demand for AUD by foreigners who want to buy government bonds)

Question 6

What is the disadvantage of borrowing from the RBA to fund a budget deficit?

Answer 6

Can be highly inflationary because there is more money with which to buy the same amount of goods and services, leading to higher prices

Question 7

What was the Australian Government’s fiscal stance in 2023?

Answer 7

Contractionary

Question 8

What have some recent discretionary changes to taxation been in Australia?

Answer 8

Stage 3 tax cuts - in 2024, the government will abolish one of the tax brackets, making the tax system less progressive

Question 9

What have some recent non-discretionary changes to government spending been in Australia?

Answer 9

Unemployment has fallen from 7.4% in 2020 to 3.5% in 2023, so spending on JobSeeker has more than halved

Question 10

What have some recent non-discretionary changes to taxation been in Australia?

Answer 10

Due to the ToT boom and low unemployment, tax revenue was 2% of GDP higher in the 2023 budget than estimated in the previous year’s budget.

Question 11

What have some recent discretionary changes to government spending been in Australia?

Answer 11

In the pandemic:
- $100b JobKeeper
- Temporarily doubled JobSeeker (in 2020)
- One-off cash payments to welfare recipients

In 2023:
- Spending to reduce cost of living: $1.5b on electricity subsidies, $3.5b to increase availability of free doctor visits, and $4.7b to reduce the cost of childcare
- Increase in Jobseeker by $40 per fortnight, and a higher rate for people aged 55 and over

Question 12

What are some limitations of using expansionary fiscal policy?

Answer 12

• Should only be used above the NAIRU
• Doesn’t address structural issues that might be restricting growth
• Needs to pass through Parliament (so 6-12 month time lag)
• All the reasons why a deficit is bad (crowding out effect, worsens external stability, needs to be repaid by future generations)