Examine the role of fiscal policy in influencing economic activity, including the structure of the federal budget, the budget outcome, the impact of automatic stabilisers and discretionary changes, and the use of fiscal policy to manage the economy

What this dot point is asking

NESA wants you to define fiscal policy, explain how the federal Budget influences AD, distinguish automatic stabilisers from discretionary changes, and analyse recent Australian budgets. Expect a 6 to 8 mark short answer or essay option in Section IV.

The answer

Fiscal policy defined

Fiscal policy is the use of the federal Budget (and to a lesser extent state and territory budgets) to influence:

1. Aggregate demand and the level of economic activity.
2. The composition of output through choices about spending priorities.
3. The distribution of income and wealth through progressive taxation and transfer payments.

The Budget consists of:

• Revenue: primarily income tax (47 percent of revenue), company tax (18 percent), GST (15 percent), excise (5 percent), and other.
• Expenditure: social security and welfare (35 percent), health (15 percent), education (7 percent), defence (5 percent), other.

Budget outcomes

Three measures of the Budget outcome are commonly cited:

1. Underlying cash balance (UCB)

Revenue minus expenditure, excluding net capital investment in financial assets. The headline measure quoted in every Budget.

2. Headline cash balance

UCB plus net cash flows from investments in financial assets (Future Fund earnings, etc.).

3. Structural balance

The Budget balance adjusted for the position of the economy in the business cycle. Strips out cyclical effects to show the underlying stance of fiscal policy.

A deficit (UCB < 0) means expenditure exceeds revenue and the government borrows to fund the gap. A surplus (UCB > 0) means revenue exceeds expenditure and the government repays debt or accumulates assets.

Recent Australian Budget positions (federal, indicative figures):

Stance of fiscal policy

The stance of fiscal policy describes whether it is expansionary, neutral or contractionary:

• Expansionary: rising deficits or falling surpluses (structural). Stimulates AD. Used in recessions.
• Contractionary: falling deficits or rising surpluses (structural). Dampens AD. Used in booms or to repair debt.
• Neutral: no change in the structural balance.

The 2020-21 stimulus during COVID-19 was the largest peacetime fiscal expansion in Australian history. The 2022-23 and 2023-24 budgets shifted to a contractionary stance, helping the RBA's effort to bring inflation back to target.

Automatic stabilisers

Automatic stabilisers are features of the Budget that dampen cyclical fluctuations without any active policy change:

During expansion:

• Income tax revenue rises faster than nominal GDP (progressive tax brackets, bracket creep).
• Company tax revenue rises with profits.
• Transfer payments (JobSeeker, Family Tax Benefit) fall as employment rises.
• The Budget moves toward surplus.

During recession:

• Tax revenues fall.
• Transfer payments rise (more JobSeeker claimants).
• The Budget moves toward deficit.

Automatic stabilisers add a counter-cyclical fiscal impulse worth roughly 30 percent of any GDP shock (Treasury estimates).

Discretionary fiscal policy

Discretionary changes are deliberate decisions to change tax rates, transfer levels or spending programs. Examples:

• 2008 GFC stimulus. $42 billion Nation Building and Jobs Plan (Rudd government).
• 2020 COVID-19 stimulus. JobKeeper ($90 billion), JobSeeker supplement, cash flow boost for businesses, HomeBuilder, totalling approximately$250 billion.
• 2024 Stage 3 tax cuts. Recalibrated as larger cuts for low and middle income earners, costing around $20 billion per year (Treasury Budget 2024-25).
• Energy bill rebates. $300 to most households in 2024-25.

Discretionary policy has the advantage of targeting (you can direct stimulus to specific groups or sectors) but the disadvantage of timing lags (Parliament must legislate; implementation takes months).

The fiscal multiplier

The fiscal multiplier is the change in GDP per dollar of fiscal stimulus. Treasury estimates Australian multipliers in the range of 0.6 to 0.9 for short-run output effects, depending on:

• Type of stimulus. Direct payments to low-income households have higher multipliers (high MPC). Tax cuts to high-income households have lower multipliers (higher saving propensity).
• State of the economy. Multipliers are higher in recessions (excess capacity, lower crowding out).
• Monetary policy response. If the RBA tightens to offset fiscal stimulus, the effective multiplier is reduced.

Public debt

Funding deficits requires borrowing. Australian Government Securities (AGS) are issued by the Australian Office of Financial Management. Gross debt is around $930 billion in 2024-25; net debt around$530 billion (around 22 percent of GDP).

Australia's public debt is moderate by international standards:

Australia retains AAA sovereign credit ratings from S&P, Moody's and Fitch.

Constraints on fiscal policy

1. Time lags

Recognition lag (recognising a slowdown), decision lag (preparing legislation), implementation lag (rolling out programs), impact lag (multiplier effects take quarters to work). Total often 12 to 18 months.

2. Political constraints

Tax rises and spending cuts are unpopular.

3. Crowding out

Higher government borrowing may raise interest rates, partially offsetting the stimulus (limited in Australia given small bond market relative to global capital markets).

4. Sovereign credit ratings

Persistent large deficits risk a credit rating downgrade, raising borrowing costs.

5. Intergenerational equity

Deficit financing transfers the cost of current consumption to future taxpayers.

Fiscal policy and inflation control

The 2022-24 inflation episode highlighted the role of fiscal policy in supporting monetary policy. The 2023-24 Budget returned a surplus, helping the RBA's effort to bring inflation back to the 2 to 3 percent target. Treasury and the RBA increasingly coordinate (the "Statement on the Conduct of Monetary Policy" 2023 reaffirmed the framework).

Common HSC traps

Confusing the Budget balance with the level of public debt

The Budget balance is a flow; debt is the cumulative stock.

Treating fiscal policy as automatic

Distinguish automatic stabilisers (no policy change) from discretionary policy (active legislative action).

Forgetting the structural balance

A cyclical surplus during a boom is less impressive than a structural surplus. Markers reward responses that distinguish.