Chapter 22 Fiscal policy

1. Chapter 22Fiscal policy Budget Expenditure Budget Revenue

2. Lecture Plan • Defining fiscal policy • Revenue and expenditure • Budget outcomes and stances • Impact of budget imbalances • Non-discretionary fiscal policy • Discretionary fiscal policy • Financing a budget deficit • Strengths and weaknesses of fiscal policy

3. Fiscal Policy Definition • The budgetary stance of the central government of a country • Changes in government spending and tax collections for the purpose of achieving full employment and non-inflationary economic growth • Therefore the aim of fiscal policy is to control the level of demand in the economy

4. Revenue sources Direct taxation e.g. Personal income tax Company tax Indirect taxation e.g. Sales tax Excise duties Gains tax Non-tax revenue e.g. Asset sales, interest and rent Areas of spending Social security and welfare Payments to state governments Defence and public order Education General public services Economic affairs Public debt interest Budget Revenue and Spending

5. Australian Budget Aggregates,A$ Billion, 2003–04 and 2004–05 2003–04 2004–05 * Expenditures 180.6 191.8 Receipts 185.2 194.2 Deficit (–)/Surplus (+) + 4.6 + 2.4 * projection Source: Australian Federal Government Budget papers, May 2004.

6. Australia’s Federal Budget Receipts by Main Sources 2001–02 Source: Federal Government Budget Papers, May 2002.

7. Budget Revenue and Expenditure

8. Budget Outcomes and Budget Stances

9. Budget Impacts • Budget surplus impact • Under a budget surplus, aggregate demand falls • Because of the Multiplier the fall in economic activity is greater than the change(s) in revenue and/or expenditure • See text Figure 22.2, p. 396 • Budget deficit impact • Under a budget deficit, aggregate demand rises • Because of the Multiplier the rise in economic activity is greater than the change(s) in revenue and/or expenditure • See text Figure 22.3, p. 397

10. Expansionary fiscal policy Problem: unemployment and deflation Remedy: induce an expansion in aggregate demand (AD) by pursuing a budget deficit Government action - Increase G - Decrease T, or - A combination of both Contractionary fiscal policy Problem: demand-pull inflation Remedy: induce a contraction in the AD by pursuing a budget surplus Government action - Increase T - Decrease G, or - A combination of both Summary of Fiscal Policy

11. Non-discretionary Fiscal Policy (Automatic Stabilisers) • Those aspects of budget which come into play to offset changes in income and expenditure associated with the business cycle • Automatic changes in tax receipts • Unemployment benefits and social welfare • The overseas component of the budget deficit results from federal government spending overseas less federal government revenues overseas; neutral impact

12. Discretionary Fiscal Policy • Those aspects of the Budget over which the government exercises control • Automatic stabilisers cannot eliminate 100% of the impact of changes in the business cycle • Consequently, the government deliberately changes taxation levels (revenue) or its expenditure to achieve the goals of macroeconomic management (e.g. economic growth)

13. Financing a Deficit • The government can borrow from • Private sector (e.g. sale of bonds): expansionary • Reserve Bank (‘printing money’): money supply up • Public (sale of securities to the public): neutral • Overseas (adds to Australia’s foreign debt) • Public sector borrowing requirement (PSBR) increases in a budget deficit situation • ‘Crowding-out’ (drain in the pool of funds available for private borrowers)

14. Fiscal Policy Strengths and Weaknesses • Strengths • Transparency • More effective in a recession in stimulating AD than monetary policy • Can target specific groups in the community with assistance • Its effect can be immediate • Weaknesses • Uncertainty of its outcomes • Timing/implementation lags • Political sensitivity • ‘Crowding-out’ effect of budget deficit