4.13 The RBA’s monetary policy stance

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Weblink The 2016–17, 2017–18 and 2018–19 budgets

4.8 Activities

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4.8 Exercise 1. Describe the changing domestic macroeconomic conditions that have recently existed in Australia. 3 marks 2. Giving reasons, explain whether recent budget outcomes been expansionary or contractionary. 2 marks 3. Identify and explain three important budget initiatives from the last two years that have been used to affect

Australia’s domestic macroeconomic goals. 3 marks 4. Examine figure 4.16.

FIGURE 4.16 The countercyclical operation of the Australian government’s budgetary policy as a stabiliser of aggregate demand and economic activity 7 00 000 6 00 000 5 00 000 4 00 000 3 00 000 2 00 000 1 00 000 –1 00 000 –2 00 000 2016–17 2017–18 2018–19 2019–20 2020–21 Year

Value ($ millions) 2021–22* 2022–23* 2023–24* 2024–25*

Australian government budget receipts, budget outlays and underlying budget outcome ($ millions) 0 UNCORRECTED PAGE PROOFS Underlying budget balance ($ millions) Receipts or revenues ($ millions) Outlays or expenses ($ millions)

Source: Australian government, Budget 2021–22, MYEFO December 2021, Appendix E: Historical Australian Government Data, PP330–333, see https://budget.gov.au/2021-22/content/myefo/download/myefo-2021-22.pdf

a. Identify and explain the likely causes of the ongoing budget deficits in recent years (as shown in figure 4.16). 4 marks b. As a branch of aggregate demand policy, explain how recent budgets have helped to promote ‘jobs and growth’. 6 marks c. Explain how you would expect any two of the following discretionary budgetary measures as part of aggregate demand policy to affect the rate of demand inflation and the rates of economic growth and unemployment. 4 marks i. Discretionary reductions in the rates of company and PAYG taxes (as seen in recent budgets) ii. Increased defence spending on new imported equipment and overseas peacekeeping iii. The JobSeeker and JobKeeper measures in the COVID-19 stimulus packages commencing early in 2020 iv. An increase in the value of instant tax write-off for small and medium-sized businesses v. A huge increase in government investment spending on national infrastructure projects to $115 billion over the next 10 years. d. Outline two general ways whereby a budget deficit could eventually be returned to surplus. 2 marks e. Identify and explain two important reasons why a return to a budget surplus in the medium-term could be seen as desirable. 2 marks f. Assume that you are the federal treasurer right now. You are about to deliver a budget in the next few weeks that seeks to promote domestic economic stability and improve living standards. i. Identify and outline the three most important factors or events that would affect your budgetary policy stance at this time. 3 marks ii. In this situation, explain the operation of automatic (cyclical) stabilisers and discretionary (structural) stabilisers in your budget that would help improve domestic stability at this time. Include reference to specific discretionary policies you would use. 4 marks Fully worked solutions and sample responses are available in your digital formats. 4.9 Strengths and weaknesses of using budgetary policy to affect aggregate demand and influence the achievement of domestic macroeconomic goals and living standards KEY KNOWLEDGE • the strengths and weaknesses of using budgetary policy to affect aggregate demand and influence the achievement of the domestic macroeconomic goals and living standards. Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission To optimise the success of budgetary measures, the treasurer needs to be mindful of policy strengths and weaknesses. 4.9.1 The strengths of using budgetary policy to achieve Australia’s domestic macroeconomic goals Table 4.7 summarises some of the key strengths of using budgetary policy to help promote the achievement of domestic macroeconomic goals and livings standards.UNCORRECTED PAGE PROOFS

TABLE 4.7 Some possible strengths of using budgetary policy to promote the achievement of macroeconomic goals and living standards

Possible strength Description of strength 1. Automatic and some discretionary stabilisers can work quickly as stabilisers, because they have quite short time lags

Many government economic policies involve three types of time lags and so can take years to work making them less useful as a stabiliser. There is the recognition lag for identifying the problem — this is due to the existence of lagging indicators like GDP; the implementation lag in activating the policy; and the impact lag in waiting for the policy to actually boost or slow AD and economic activity. A powerful advantage of automatic budget stabilisers is that they work very quickly in a countercyclical way to affect AD and reduce economic instability, with almost no time lag. For instance, the moment the economy slows and incomes fall and unemployment rises, tax receipts will automatically decline and welfare outlays rise, causing the budget stance to quickly become a more expansionary deficit, boosting AD. In contrast, we will soon see that monetary policy involving changes in interest rates can take up to three years to be fully effective. In addition, as shown by the Coronavirus Stimulus Package of early 2020, sometimes, discretionary budget outlays (e.g. the temporary doubling of some welfare benefits) can also be activated quite quickly to help stimulate household C spending and AD.

2. Discretionary policy can precisely target particular areas of greatest weakness

Budgetary policies involving changes in receipts and expenses can precisely and powerfully target particular economic problems in different parts or sectors of the economy that are most in need of support. For instance, the budget can surgically alter the allocation of resources to specific industries like health, education, aviation, construction and the environment, and help the aged or homeless. There is the capacity to help those affected by natural disasters, the unemployed, the deficiency in investment or consumption spending and bottlenecks in transport. It can also discourage the consumption of particular harmful products like alcohol, as well as operate more generally on the macro level to affect national consumption, investment, government spending, net exports, AD and GDP. Potentially, this makes budgetary policy a very versatile and precise instrument. In contrast, we will soon see that monetary policy involving a change in interest rates is more general and cannot precisely target areas of weakness.

3. Especially in a recession, budget measures can directly boost AD

The budget can work in a very direct way to affect AD and economic activity. For instance, in a recession, reduced budget receipts and increased outlays (leading to an expansionary rise in the budget deficit) can be used to inject extra cash or disposable income directly into the hands of householders and businesses, where they are likely to spend at least most of it. Additionally, discretionary government consumption (G1) and investment spending (G2) can also directly feed extra expenditure into the economy to lift economic activity (although this is likely to add to the deficit and government debt that may take years to repay). In reverse, during inflation, automatic rises in receipts and cuts in welfare outlays can directly hold down AD, slowing the economy. Shortly we will see that using monetary policy and lower interest rates in a recession to stimulate AD, do not work all that directly, especially in a slowdown, and hence, might not be very effective. This is especially likely when cuts in interest rates are very small because they are already close to zero and there is little room for further reductions. For this reason, expansionary budgetary policy has had to do much of the heavy lifting and provide the necessary stimulus during the recent 2020 recession.

4. Some budget measures can also grow aggregate supply, as a bonus

We know that budgetary policy can help stabilise aggregate demand. However,UNCORRECTED PAGE PROOFS as we will see in Topic 5, an added bonus is that lower tax rates and outlays on infrastructure and education, can also improve aggregate supply conditions for businesses and individuals, grow productive capacity and improve both material and non-material living standards.