“c04AggregateDemandPoliciesAndDomesticEconomicStability_PrintPDF” — 2022/6/7 — 8:31 — page 332 — #46
4.9.2 The weaknesses of using budgetary policy to achieve Australia’s domestic macroeconomic goals Table 4.8 summarises some of the key weaknesses of using budgetary policy to help promote the achievement of domestic macroeconomic goals and livings standards.
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TABLE 4.8 Some possible weaknesses of using budgetary policy to promote the achievement of domestic macroeconomic goals and living standards Description of weakness
1. Some discretionary budget stabilisers can become procyclical due to their long time lags between recognition of a problem in economic activity and the impact of the corrective policy
There are often long time lags associated with the recognition, implementation and impact of some discretionary budgetary policies like spending on large transport, power and telecommunications infrastructure projects. Because of delays in planning, starting and completing these projects, and spending the money, there is a real risk they can become procyclical rather than countercyclical, possibly increasing instability in AD. This can mean that changing discretionary budget stabilisersare of limited use in correcting shortterm or cyclical instability like a recession. Their full impact on the level of AD and economic activity can take 3–8 years or even longer and so are often more suited to promoting medium- to long-term stability. In the opposite situation where there is a boom, the same sort of pro-cyclical risk applies. For example, if there were discretionary cuts in infrastructure to limit AD, the policy may do little to slow inflation in the short-term, and instead gain traction when inflation has passed and the economy is in recession. However, as noted, some discretionary budget stabilisers can work quite quickly to help stimulate AD (e.g. a rise in the payment rate for welfare or a cash bonus paid to households).
2. Financial constraints and the creation of a structural budget deficits can limit budget options during a slowdown
Like individuals, governments face financial constraints where there is limited money available for spending without increasing unpopular taxes or adding to already high levels of government debt. For instance, during a slowdown like in 2020 and 2021, the government may want to make big discretionary cuts in tax rates, increase outlays and run expansionary budget deficits to help stimulate AD and economic activity. However, the benefits of such action would have to be balanced against the repayment burden that this action would place on future generations and potentially, the negative impacts on Australia's AAA credit rating. In other words, concern over the impact of huge deficits on the government's long-term financial position, is likely to mean that the strength of stimulus budget measures may be less than that actually needed for promoting a significant recovery. This weakens the policy's effectiveness.
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3. Budgetary policy can undermine the effectiveness of monetary policy through the problems of crowding out or crowding in
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Budgetary policy used as a stabiliser can sometimes undermine the effectiveness of monetary policy. For instance, when the economy is in recession and the government decides to run large budget deficits to stimulate AD financed by borrowing through the sale of government bonds domestically, this can increase the demand for credit in local financial markets. As an unintended result, this puts upward pressure on local interest rates at a time when it would be better to have lower interest rates to boost spending. In turn, higher interest rates can lead to the problem of crowding-out private sector C and I spending, unfortunately slowing the economy. In reverse, when there are budget surpluses during a boom designed to slow AD and economic activity and the government decides to repay previous debt, this can cause lower interest rates and lead to the problem of crowding-in by borrowers, adding to spending, inflationary pressures and instability.
Key Concepts VCE Economics 2 Units 3 & 4 Eleventh Edition
