Introductory Macroeconomics Lecture 8: Fiscal Policy PDF

Introductory Macroeconomics Lecture 8: Fiscal Policy Jonathan Thong Daniel Minutillo 2nd Semester 2024 1  Announcement Online multiple choice test: available from 9:00 August 15 (Th) to 21:00 August 16 (Fri) Click ‘Qui...

Introductory Macroeconomics Lecture 8: Fiscal Policy Jonathan Thong Daniel Minutillo 2nd Semester 2024 1  Announcement Online multiple choice test: available from 9:00 August 15 (Th) to 21:00 August 16 (Fri) Click ‘Quizzes’ tab on the Canvas LMS page Test time: 30 minutes Covers lectures 1-6 and Tutorials 1-3 2  This Lecture Fiscal policy in ordinary times – basic fiscal policy concepts – more on fiscal policy and demand management – government budget constraint, debts and deficits Fiscal policy in extraordinary times – response to the global financial crisis – response to the covid pandemic BOFAH chapter 8 3 Basic Fiscal Policy Concepts 4  Basic Fiscal Policy Concepts Government decisions to spend, raise revenue, and issue debt Expenditure – government 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 – personal and company income taxes, GST, excises, land taxes Levels of government (commonwealth, state, local) 5 Government Expenditure Across Countries 6 Government Revenue Across Countries 7 Fiscal Policy and Demand Management 8  Fiscal Policy and Demand Management Keynes argued should use fiscal policy to stabilise business cycle Use G and T to offset temporary shortfalls in private spending 9 Limits of Fiscal Policy in Demand Management Possible side-effects – changes in taxes may distort incentives to work and invest – deficit-financed government spending may push up interest rates, ‘ crowding out ’ private sector investment Practical concerns – lags in making and implementing decisions – lags between decision and time spending effects economy – tension between getting timing right and most worthwhile spending (e.g., infrastructure timing) – waste 10 Government Budget Constraint, Debts and Deficits 11  Government Budget Constraint Period-by-period government budget constraint G + iBt + T ransf erst = T axest + (Bt+1 − Bt ) |t {z } | {z } uses of funds sources of funds where Gt = government purchases of goods and services iBt = interest payments on existing government debt Bt+1 − Bt = change in government debt T ransf erst = transfer payments from government T axest = tax revenue To simplify notation Tt = T axest − T ransf erst = net taxes 12  Government Budget Constraint With Tt denoting net taxes (taxes minus transfers) Gt + iBt = Tt + (Bt+1 − Bt ) | {z } | {z } uses of funds sources of funds What is the relationship between debt and the government deficit? 13  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 sum of primary deficit Gt − Tt plus interest payments iBt on existing government debt Hence positive deficit Bt+1 − Bt > 0 ⇔ debt increasing negative deficit Bt+1 − Bt < 0 ⇔ debt decreasing 14 Government Deficits Relative to GDP 15 Government Debt Relative to GDP 16 Australian Government Debt to GDP 17  Gross Debt vs. Net Debt So far, we have only considered gross government debt What if we look at the asset side of balance sheet? (e.g., future fund for Australia, or other sovereign wealth funds) Assets minus liabilities gives a measure of government net wealth 18 Government Net Wealth Relative to GDP 19 Can Governments Keep Accumulating Debt? Government period-by-period budget constraint Bt+1 − Bt = Gt − Tt + iBt Need to rollover the period-by-period budget constraint To get a complete complete picture (over a long time-horizon) Result is the government’s ‘ intertemporal budget constraint ’ After some algebra (omitted), intertemporal budget constraint is ∞  t 1 X 1 B0 = = (Tt − Gt ) 1+i 1+i t=0 Borrowing constrained by present value of future primary surpluses 20 Fiscal Response to the GFC 21 Australia and the Global Financial Crisis 22  Australia Pursued Fiscal Stimulus Australia pursued a fairly aggressive fiscal stimulus – October 2008: $10 billion. $5 billion for pensioners, $4 billion for families, $1 billion first home buyers ($1400 one-off pensioner payments, $1000 one-off family benefit, tripling of first home buyer grant...) – February 2009: $42 billion. $26 billion infrastructure, $12.7 billion cash payments, $2.7 billion small-business tax breaks ($200k per school building program, $4 billion insulation scheme, $950 one-off payment for most taxpayers...) In many other countries, especially in Europe, fiscal policy focused on trying to keep budget in balance — ‘ austerity ’ 23 Budget Moves Back Into Deficit 24  Budget Moves Back Into Deficit Budget moves into deficit for two kinds of reasons – automatic stabilisers: more unemployed, more newstart etc recipients, less tax collected from individuals and businesses (in boom, automatic stabilisers work in reverse, reduce deficit) – discretionary spending: one-off transfer payments, new infrastructure projects etc For future reference, note peak deficit about 4% of GDP Optimistic forecasts of return to surplus — ‘back in black’ 25 Fiscal Response to Coronavirus Pandemic 26 Coronavirus Pandemic 27 Coronavirus Pandemic: Economic Fallout 28 Coronavirus Pandemic: Economic Fallout 29  Fiscal Response in Australia I Why did fiscal policy play a lead role? – monetary policy had almost reached its limits – fiscal policy more direct Immediate fiscal response – March 12: $18 billion. Bulk is business investment and cash-flow support. First one-off $750 payment to social security etc recipients – March 22: $66 billion. $550pw coronavirus supplement to JobSeeker etc recipients. Second one-off $750 payment to social security etc recipients. Limited early access to superannuation, up to $10k – March 31: $130 billion. $750pw JobKeeper subsidies for workers in conditions significantly affected by downturn 30  Fiscal Response in Australia II Additional fiscal response: 2020-21 budget – $17.8 billion personal income tax cuts – business investment incentives (instant asset write off) – home builder and infrastructure spending – JobMaker and supporting apprentices and trainees Treasury estimates total direct support ≈ $160 billion to June 2021 Key problem: budget did not engage with unusual nature of the crisis – especially vaccine procurement and rollout 31 Estimated Effects of Total Stimulus Treasury Budget Paper #1, October 2020 32 Estimated Effects of Total Stimulus Treasury Budget Paper #1, October 2020 33  Learning Outcomes 1 Be familiar with some empirical facts and trends in relation to fiscal policy in Australia and globally. 2 Understand and explain some basic fiscal policy concepts, including categories of expenditure and sources of revenue. 3 Understand and explain the benefits and concerns of demand management through fiscal policy. 4 Understand the Government Budget Constraint and the relationship between debt and deficits. 5 Be familiar with Australia’s policy responses to the GFC and Covid Pandemic crises. 34  New Formula(s) and Notation The Government’s Budget Constraint Gt + iBt = Tt + (Bt+1 − Bt ) B bonds (government borrowing) 35  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 BOFAH chapters 9 and 10 36