Basic Fiscal Policy Concepts

Basic Fiscal Policy Concepts

• Governments use fiscal policy by making decisions about spending, raising revenue and issuing debt.
• Government spending includes:
  • Purchases of goods and services (schools, police, courts, military, roads)
  • Transfers to households and firms (age pension, newstart, parental support)
  • Interest payments to holders of government debt
• Revenue is collected through:
  • Personal and company income taxes, GST, excises, land taxes
• Fiscal policy is implemented at multiple levels of government, such as commonwealth, state and local.

Government Expenditure Across Countries

• Government expenditure varies significantly across countries.

Government Revenue Across Countries

• Government revenue also varies significantly across countries.

Fiscal Policy and Demand Management

• John Maynard Keynes argued that fiscal policy should be used to stabilise the business cycle.
• Offset temporary shortfalls in private spending using government spending, G, and taxation, T.

Limits of Fiscal Policy in Demand Management

• Potential side-effects:
  • Changes in taxes may distort incentives to work and invest
  • Deficit-financed government spending may increase interest rates and crowd out private sector investment.
• Practical concerns:
  • Lags in making and implementing decisions
  • Lags between the decision-making process and when the spending effects the economy
  • Tension between getting timing right and choosing the most worthwhile spending
  • Waste

Government Budget Constraint, Debts and Deficits

• Period-by-period government budget constraint:
  • G + iBt + Transfers = Taxt + (Bt+1 − Bt)
    • G: Government purchases of goods and services
    • iBt: Interest payments on existing government debt
    • (Bt+1 − Bt): Change in government debt
    • Transfers: Transfer payments from government
    • Taxt: Tax revenue
• To simplify the notation we can use Tt which is net taxes; taxes minus transfers:
  • Gt + iBt = Tt + (Bt+1 − Bt)

Debts and Deficits

• The amount of government debt is Bt.
• Government deficit is the change in government debt:
  • Bt+1 − Bt = Gt + iBt − Tt
• Deficit is the sum of the primary deficit (Gt − Tt) plus interest payments (iBt) on existing government debt.
• A positive deficit (Bt+1 − Bt > 0) results in an increase in debt whereas a negative deficit (Bt+1 − Bt < 0) results in a decrease in debt.

Government Deficits Relative to GDP

• Government deficits relative to GDP are a measure of the size of the deficit in relation to output.

Government Debt Relative to GDP

• Government debt relative to GDP is a measure of the size of the debt in relation to output.

Australian Government Debt to GDP

• The Australian government debt to GDP is a measure of the long term sustainability of government finances.

Gross Debt Vs. Net Debt

• We've considered gross government debt so fare.
• The asset side of balance sheet can be reviewed to determine government net wealth.
  • Assets minus liabilities gives a measure of government net wealth.

Government Net Wealth Relative to GDP

• The Government net wealth is a measure of the true net wealth of the government.

Can Governments Keep Accumulating Debt?

• The government period-by-period budget constraint is:
  • Bt+1 − Bt = Gt − Tt + iBt
• The complete picture is only captured in the intertemporal budget constraint (long time-horizon).
• Borrowing is constrained by the present value of future primary surpluses.

Fiscal Response to the GFC

• The Global Financial Crisis was a significant economic downturn with a global impact.

Australia and the Global Financial Crisis

• Australia was affected by the GFC and implemented a fiscal stimulus.

Australia Pursued Fiscal Stimulus

• Australia's fiscal stimulus was fairly aggressive.
  • October 2008: 10billion(10 billion (10billion(1400 one off pensioner payments, $1000 one-off family benefit, tripling of first home owner grant)
  • February 2009: 42billion(42 billion (42billion(200k per school building program, 4billioninsulationscheme,4 billion insulation scheme, 4billioninsulationscheme,950 one-off payment for most taxpayers)
• The fiscal stimulus was a contrast to many other countries, particularly in Europe, where fiscal policy focused on ‘austerity’ which maintains a balanced budget.

Budget Moves Back into Deficit

• The budget moved into a deficit due to:
  • Automatic stabilisers: unemployed, newstart recipients, and those on social services
  • Discretionary spending: one-off transfers, new infrastructure, etc.
• The peak deficit was about 4% of GDP.

Fiscal Response to Coronavirus Pandemic

• The coronavirus pandemic resulted in a significant economic downturn.

Coronavirus Pandemic: Economic Fallout

• The pandemic had negative impacts on the world economy, including economic uncertainty, supply chain constrictions, and an increase in demand for essential services.

Coronavirus Pandemic: Economic Fallout

• The downturn caused significant economic hardship in many countries.

Fiscal Response in Australia I

• Fiscal policy played a lead role in responding to the pandemic as monetary policy reached its limits.
• Immediate fiscal response:
  • March 12: $18 billion (primarily business investment and cashflow support)
  • March 22: 66billion(coronavirussupplement,one−off66 billion (coronavirus supplement, one-off 66billion(coronavirussupplement,one−off750 payment, early access to superannuation)
  • March 31: $130 billion (JobKeeper subsidies)

Fiscal Response in Australia II

• Additional fiscal response: 2020-21 budget
  • $17.8 billion in personal income tax cuts
  • Business investment incentives
  • Infrastructure spending, including home building
  • JobMaker and supporting apprentices and trainees
• Direct support:
  • Total direct government support was estimated at $160 billion by June 2021.
• The main problem with this fiscal response was a failure to engage with the unusual nature of the crisis, in particular vaccine procurement and rollout.

Estimated Effects of Total Stimulus

• Treasury estimated the effects of the total stimulus package in its budget papers.

Estimated Effects of Total Stimulus

• Treasury estimated the effects of the total stimulus package in its budget papers.

Learning Outcomes

• Understand the basic concepts for fiscal policy.
• Be familiar with the empirical facts and trends in fiscal policy globally.
• Understand the potential effects of using fiscal for demand management.
• Understand the government budget constraint and the relationship between debt and a deficit.
• Be familiar with the policy responses of the Australian Government to the GFC and the Coronavirus Pandemic.

New Formula(s) And Notation

• The Government’s Budget Constraint:
  • Gt + iBt = Tt + (Bt+1 − Bt )
  • B: represents bonds (government borrowing)

Next Lecture

• Monetary Policy, Part 1
  • Basic Monetary Policy concepts
  • Monetary Policy in the Long Run: the quantity theory of money
  • Monetary Policy in the short run
  • Monetary Policy Transmission Mechanism

Basic Fiscal Policy Concepts

• Government actions include spending, taxation and borrowing
• Government expenditure includes spending on goods and services such as schools, police, military and roads
• Government expenditure also includes transfer payments to households and firms, such as age pensions, unemployment benefits and parental support
• Government revenue comes from personal and company income taxes, Goods and Services Tax (GST), excise taxes, and land taxes
• Government revenue comes from federal, state and local governments, taxes such as sales tax, value-added tax, and property tax can be collected by each level.

Fiscal Policy and Demand Management

• Keynes argued that fiscal policy should be used to stabilize the economy
• Governments can use government spending (G) and taxes (T) to offset fluctuations in private sector spending
• Examples include government spending on infrastructure projects to stimulate the economy, or tax cuts to boost consumer spending

Limits of Fiscal Policy in Demand Management

• Changes in taxes can distort incentives to work and invest
• Deficit-financed government spending can push up interest rates, potentially crowding out private sector investment

Government Budget Constraint, Debts and Deficits

• The government budget constraint is the equation that shows how government spending, borrowing, and taxation are related
• The equation is: Gt + iBt = Tt + (Bt+1 − Bt), where Gt is government purchases of goods and services, iBt is interest payments on existing government debt, Tt is net taxes (taxes minus transfers), and Bt+1 − Bt is the change in government debt
• Government deficit is the change in government debt, Bt+1 − Bt = Gt + iBt − Tt
• Deficit is the sum of the primary deficit, Gt − Tt, and interest payments, iBt
• A positive deficit means government debt is increasing

Government Deficits Relative to GDP

• Australian government deficit is often expressed in terms of GDP

Government Debt Relative to GDP

• Australian government debt is often expressed in terms of GDP

Government Debt to GDP

• The Australian government’s debt-to-GDP ratio has been on an upward trend in recent years

Gross Debt vs. Net Debt

• The government's balance sheet has assets and liabilities
• Net debt is gross debt minus assets, including government assets such as Future Fund or other sovereign wealth funds
• Net debt is a more accurate measure of the government's financial position

Fiscal Response to the GFC

• Australia pursued a fairly aggressive fiscal stimulus in response to the Global Financial Crisis (GFC)
• Stimulus included one-off payments to pensioners, families, and first home buyers
• Stimulus also included infrastructure projects, cash payments, and small business tax breaks
• Many other countries, especially in Europe, focused on trying to keep their budgets in balance through austerity measures

Budget Moves Back Into Deficit

• The budget moved into deficit due to automatic stabilisers and discretionary spending
• Automatic stabilisers lead to more unemployment benefits and less tax collections during recessions
• Discretionary spending includes one-off transfer payments and new infrastructure projects

Fiscal Response to Coronavirus Pandemic

• Fiscal policy played a lead role in the economic response to the Coronavirus pandemic
• Monetary policy had almost reached its limits
• Fiscal policy was more direct and could be implemented quickly
• The immediate fiscal response included business investment and cash-flow support, one-off payments to social security recipients, and jobkeeper subsidies for affected workers
• The 2020-21 budget included personal income tax cuts, business investment incentives, and home builder and infrastructure spending

Estimated Effects of Total Stimulus

• Treasury estimated that the total stimulus package would boost GDP by 5.5% to 6.5% in 2020-21

Learning Outcomes

• Be familiar with facts and trends in fiscal policy globally and in Australia
• Understand basic fiscal policy concepts, including expenditure categories and revenue sources
• Understand the benefits and drawbacks of using fiscal policy to manage demand
• Understand the government budget constraint and the relationship between debt and deficits
• Be familiar with Australia’s fiscal policy responses to the GFC and the Coronavirus pandemic

New Formula(s) and Notation

• The government budget constraint: Gt + iBt = Tt + (Bt+1 − Bt)
• B represents bonds, which are used in government borrowing

Next Lecture

• Monetary Policy, Part One
  • Basic Monetary Policy Concepts
  • Monetary Policy in the Long Run - the quantity theory of money
  • Monetary Policy in the Short Run - implementation in Australia
  • Monetary Policy Transmission Mechanism

Basic Fiscal Policy Concepts

• Fiscal Policy is comprised of government decisions on spending, raising revenue, and issuing debt.
• Government Expenditure includes:
  • Purchases of goods and services (e.g., schools, police, military, roads).
  • Transfers to households and firms (e.g., age pension, newstart, parental support).
  • Interest payments to holders of government debt.
• Government Revenue includes:
  • Personal and company income taxes, GST, excises, land taxes.
• Fiscal Policy is implemented at different levels of government: the commonwealth, state, and local.

Fiscal Policy and Demand Management

• Keynesian Economics advocates for fiscal policy to stabilize the business cycle.
• Governments can offset temporary shortfalls in private spending by adjusting government spending (G) and tax revenue (T).

Limits of Fiscal Policy in Demand Management

• Potential Side Effects:
  • Changes in taxes may distort incentives to work and invest.
  • Deficit-financed government spending may increase interest rates, potentially crowding out private sector investment.
• Practical Concerns:
  • Lags exist in making and implementing fiscal policy decisions.
  • There are lags between policy decisions and the time spending effects the economy.
  • Balancing timing with the implementation of the most worthwhile spending (e.g., infrastructure projects) is a challenge.
  • Waste presents a concern for fiscal policy.

Government Budget Constraint, Debts, and Deficits

• Government Budget Constraint:
  • The Budget Constraint states: Gt + iBt + T ransf erst = T axest + (Bt+1 − Bt )
    • Gt represents government purchases of goods and services.
    • iBt represents interest payments on existing government debt.
    • T ransf erst represents transfer payments from the government.
    • T axest represents tax revenue.
    • Bt+1 − Bt represents the change in government debt.
  • To simplify, net taxes (Tt) are represented as Tt = T axest − T ransf erst.
  • The simplified equation becomes: Gt + iBt = Tt + (Bt+1 − Bt ).
• Relationship Between Debt and Deficit:
  • Government debt (Bt) is the total amount of debt owed.
  • Government Deficit is the increase in government debt, represented by: Bt+1 − Bt = Gt + iBt − Tt.
  • Deficits are the sum of the primary deficit (Gt − Tt) and interest payments on existing debt (iBt).
  • Debt increases with a positive deficit (Bt+1 − Bt > 0).
  • Debt decreases with a negative deficit (Bt+1 − Bt < 0).

Fiscal Response to The Global Financial Crisis

• Australia responded to the Global Financial Crisis (GFC) with a fairly aggressive fiscal stimulus.
  • In October 2008, $10 billion was allocated to pensioners, families, and first home buyers.
  • In February 2009, $42 billion was allocated to infrastructure, cash payments, and small business tax breaks.
• Many other countries, particularly in Europe, pursued austerity measures, focusing on balancing their budgets.

Fiscal Response to the Coronavirus Pandemic

• Fiscal policy played a prominent role in the Australian response to the Coronavirus pandemic due to the limitations of monetary policy.
• Initial fiscal responses included:
  • March 12, 2020: $18 billion dedicated to business investment and cash flow support.
  • March 22, 2020: $66 billion allocated to a coronavirus supplement for JobSeeker recipients, a second one-off payment to social security recipients, and limited early access to superannuation.
  • March 31, 2020: $130 billion for JobKeeper subsidies to support workers in industries heavily affected by the downturn.
• Subsequent fiscal responses included:
  • $17.8 billion in personal income tax cuts.
  • Business investment incentives.
  • Home builder and infrastructure spending.
  • JobMaker and support for apprentices.
• The Australian government's total direct support for the pandemic response reached approximately $160 billion as of June 2021.

Learning Outcomes

• The goal of this lecture is for students to:
  • Be familiar with empirical facts and trends related to fiscal policy in Australia and globally.
  • Understand and define the various concepts related to fiscal policy, including types of government spending and revenue.
  • Analyze the advantages and drawbacks of using fiscal policy for economic stabilization (demand management).
  • Grasp the concept of the Government Budget Constraint (intertemporal and the link between debt and deficit).
  • Gain knowledge of how Australia responded to the Global Financial Crisis (GFC) and the Coronavirus pandemic through fiscal policy.

Basic Fiscal Policy Concepts

• Fiscal policy focuses on government decisions regarding spending, revenue generation, and debt issuance.
• Government expenditure comprises:
  • Purchases of goods and services (e.g., schools, police, military)
  • Transfers to households and firms (e.g., pensions, social support)
  • Interest payments on government debt
• Revenue sources include:
  • Personal and company income taxes
  • Goods and Services Tax (GST)
  • Excises (e.g., fuel tax)
  • Land taxes
• Fiscal policy is implemented at various levels of government: Commonwealth, State, and Local.

Fiscal Policy and Demand Management

• John Maynard Keynes advocated for fiscal policy as a tool to stabilize the business cycle.
• The government can utilize spending (G) and taxation (T) to counter temporary downturns in private sector spending.

Limits of Fiscal Policy in Demand Management

• Fiscal policy can have unintended consequences:
  • Tax changes may distort incentives for work and investment.
  • Deficit-financed government spending might increase interest rates, leading to "crowding out" of private investment.
• Practical challenges include:
  • Delays in decision-making and implementation.
  • Time lag between policy implementation and economic impact.
  • Balancing effective timing with prioritizing worthwhile spending projects.
  • Potential for waste.

Government Budget Constraint, Debts, and Deficits

• The government budget constraint reflects the balance between uses of funds and sources of funds in a given period:
  • Uses of funds: G (government spending) + iBt (interest payments on existing debt)
  • Sources of funds: Tt (net taxes, including taxes minus transfers) + (Bt+1 - Bt) (change in government debt)
• Government debt (Bt) represents the total amount of outstanding debt.
• Government deficit is the change in debt (Bt+1 - Bt).
• A positive deficit indicates increasing debt, while a negative deficit signals decreasing debt.

Fiscal Response to the GFC

• Australia adopted an aggressive fiscal stimulus during the Global Financial Crisis (GFC).
• Stimulus measures included:
  • Cash payments to individuals and families
  • Increased infrastructure spending
  • Small business tax breaks
• Many European countries pursued austerity measures, focusing on budget balancing.

Fiscal Response to the Coronavirus Pandemic

• The COVID-19 pandemic led to unprecedented economic fallout, necessitating substantial fiscal intervention.
• Fiscal policy took a leading role due to monetary policy reaching its limits.
• Australia implemented a multi-phased fiscal response:
  • Immediate measures: business investment support, cash-flow support, increased social security payments.
  • Additional measures: personal income tax cuts, business investment incentives, infrastructure spending.
• The Treasury estimated the total direct support provided by fiscal policy to be roughly $160 billion by June 2021.

Learning Outcomes

• Understand the key facts and trends regarding fiscal policy in Australia and globally.
• Explain core fiscal policy concepts, including expenditure categories and revenue sources.
• Comprehend the benefits and limitations of demand management through fiscal policy.
• Explain the government budget constraint and the relationship between debt and deficits.
• Be familiar with Australia's policy responses to the GFC and the COVID-19 pandemic.