Fiscal Policy

20. Explain the concept of Fiscal Policy.

Fiscal Policy is where the government changes the levels of taxation and government spending in
order to influence the level of economic activity.
Aims to achieve full employment, low inflation (2-3%) and sustainable economic growth
21. Identify the components of government revenue and expenditure
Revenue sources include:

Direct tax (personal and company tax)

Indirect tax (customs and excise duties, GST)
Other revenue (e.g. public trading enterprises)

Major expenditure areas include:

Social welfare
Health
Education
Defence
Public Administration

22. Outline different budget outcomes i.e. balanced, surplus and deficit budgets
The Federal Budget is the annual statement from the government of its taxation and expenditure
plans for the next financial year.
This is usually announced on the 2nd Tuesday of May each year.
Budget outcomes give an indication of the overall impact of fiscal policy on the economy.
When T>G, a fiscal surplus occurs

Enables government to increase savings and reduce debt

When G>T, a fiscal deficit occurs

Requires borrowing of funds or selling government bonds/securities

When T=G, we record a fiscal balance

Not desirable as it destabilises the economy

There are 2 methods of measuring budget outcomes

Cash accounting method (underlying cash outcome)

Underlying cash balance = total revenue minus asset sales

Accrual accounting method (Fiscal outcome)

Fiscal balance = net operating balance (revenue less expenses) minus net capital

investment (spending)
Same as underlying cash outcome, however transactions are recorded as they occur

23. Account for differences between planned and actual budget outcomes
The actual budget outcome is never the same as the planned/forecasted outcome due to changes
in economic conditions and fiscal policy. These changes include:

Non-discretionary changes in fiscal policy (cyclical component)

Dependent on economic activity e.g. recession
Self-corrected by automatic stabilisers
Discretionary changes in fiscal policy (structural component)
Deliberate changes e.g. reduced spending or new tax rates
Exogenous factors (unforeseen circumstances)
Floods, earthquakes, increase in oil prices.

24. Explain the methods of financing a budget deficit and the uses of a budget surplus.
The 3 main ways a budget deficit can be financed include:

Selling government bonds

Borrowing from the central bank
Borrowing from overseas

Selling government bonds

Government bonds are a financial instrument which raises funds for the government and returns
interest to the buyer.
For example, the government will sell a bond with a value of $1000 at a rate of 10% interest per
annum, meaning the purchaser of the bond receives an extra $100 per year.
This can sometimes cause the crowding out effect, where borrowing from the public drives up
interest rates as there is less savings in private firms (banks), decreases private investment and
causes firms to borrow from overseas.

Borrowing from the central bank

This injects new money into the economy.
However, if increase in money supply exceeds increase in real output, high inflation will occur.
Borrowing from overseas
Demand for AUD will increase when converting between currencies, causing an appreciation of
AUD.
Will cause a decrease in exports and an increase in imports.
Adds to foreign debt and therefore income debits on the CAD.

A budget surplus can be used to:

Deposing it with the RBA (saving)

Pay off public sector debt

Decreases interest rates

Crowding in

Repay debt overseas

Decrease foreign debt

Decrease supply of AUD Depreciate AUD

exports and imports

25. Distinguish between automatic fiscal stabilisers and discretional fiscal policy
Automatic stabilisers are fiscal changes to the economy that will occur automatically to stabilise
the business cycle. Work through:

Progressive tax system (income tax)

If economic activity increases, income increases, moving people into higher tax

brackets.
Creates a budget surplus for government (or lower deficit) and stabilises a boom as a

result of people having less relative disposable income.

Unemployment benefits/welfare
If economic activity increases, unemployment decreases, meaning welfare payments

decrease.
Creates a budget surplus for government (or lower deficit)

From left to right on graph

The effect of automatic stabilisers on the business cycle can be seen below.

Discretionary fiscal policy is implemented by deliberate changes to the level of government

expenditure (G) and/or taxation (T).

When macroeconomic activity is below potential, the government usually runs a budget

deficit (G>T).
When macroeconomic activity is too high, the government will run a budget surplus (T>G)
A budget balance would suggest it was believed economic conditions are stable.