Economics 101: Fiscal Policy for Beginners
Wellsy’s Weekly Wisdom: “I think I should limit the questions you ask, Matt.”
T. J. Ellis
WELCOME BACK TO ANOTHER ECONOMICS 101. It will always be a pleasure to formulate a weekly guide on Economics, with the hope that older and younger students, parents and teachers will further engage with this intricate and ‘life changing’ (as described by Mr Wells – MJW) subject that I have had the pleasure of studying for the last two and a bit terms. So, let’s jump right into the other side of countercyclical macroeconomic policy: fiscal policy.
To give you readers a quick recap, we defined any policy that was countercyclical as a form of stabilisation of the inflation-ponderous peaks, and the unemployment-heavy troughs, through their respective macroeconomic instruments. Additionally, we defined macroeconomic policy as any policy which concerned itself with the operation of an economy and the adjustment of aggregate demand (C+I+G+(X-M)) in order to meet economic objectives in the short term. So what is fiscal policy? Essentially, fiscal policy refers to the government’s use of its annual budget to affect the level of economic activity (or AD), resource allocation and income distribution. The ‘meat’ behind fiscal policy consists of two main chunks: government expenditure and Tax Revenue. The value of these two ‘chunks’ of Australia’s fiscal policy strategy are outlined in the Australian Federal Budget.
Australia’s 2022-23 Federal Budget used these two variables in order to facilitate an economic environment conducive to recovery (dampening of inflation following launch of the C19 recovery package) and the easing of the cost-of-living crisis that some of you have heard of, or maybe even experienced (sorry parents and teachers). Within the 2022-23 budget, the Australian Government utilised a combination of government spending (which can be both cyclical or discretionary) and tax revenue in order to achieve certain inflation and unemployment targets within the economy. For example, due to the current cost-of-living crisis, which saw a 7% rise in the CPI in the March 2023 quarter, the Australian government employed a variety of relief packages. This included the $3 billion energy relief package, the $1.3 billion household-energy upgrades fund and the triple bulk billing incentive valued at $3.5 billion (delivered over a period of 5 years) – all to assist with improving societal prosperity and dampening the cost-of-living crisis. These features of the 2022-23 budget outlined above are known as discretionary (deliberate) changes to the Australian budget composition which alter the budget outcome (whether the budget results in an expansion or contraction in aggregate demand).
However, the government has another government-expenditure tool at its disposal – automatic (cyclical) stabilisers. Essentially, these bad boys ease the stress of Jim Chalmer’s role as the Australian Treasurer, as they adapt in a cyclical fashion to respond to changes in the level of aggregate demand in the economy. Progressive taxation and expenditure on welfare payments are two great examples of automatic stabilisers within the Australian fiscal strategy. Without having to directly change aspects of the Australian Budget, these mechanisms of government expenditure and tax revenue cyclically adjust to changes in the level of aggregate demand within the economy.
Some of you might be asking – where on earth does the Australian government acquire all this money to fund 15 consecutive budget deficits? (Sorry Jim). Well, the Australian Government has three tools at its disposal, in the fuelling of the fiscal policy train if you will. Borrowing from the private sector through the exchange of cash for Commonwealth Government Securities (commonly called government bonds) is the most common form of government financing of the annual fiscal strategy. Essentially, if the government requires cash, they can offer private sector businesses the opportunity of owning a bond which yields a fixed level of interest until bond maturity, in exchange for cash. When the bond does reach maturity, the government can reimburse the bond owner through the repayment of the CGS’ principle and bond yield interest payments.
The second option, which Mr Wells (a highly decorated economist) believes the Australian government “should not go near as the RBA needs to stay in its own lane”, involves the borrowing of funds from the RBA in order to finance a government’s fiscal strategy. Known as monetary financing, it involves the exchange of CGSs for cash. When the Australian Government requires some more cash, it can instruct the RBA to print more money which it uses to buy CGS – a rookie error considering how it contributes to inflation as the purchasing parity of $AUD falls.
Finally, the Australian government can finance its fiscal strategy by borrowing from overseas financial markets. By issuing CGS in exchange for cash, the Australian government can acquire the cash it desperately needs to make its fiscal function easier.
So that’s fiscal policy for ya – hope you all enjoyed reading about another policy which seems to be on a lot of people’s minds at the moment.