Few factors have the scale of impact on an economy as fiscal policy, notwithstanding huge market shocks such as the 1929 and 1987 stock market crashes. This means that fiscal policy includes the large-scale capital inflows and outflows by the federal or national government of a country. As a result, it can have rapid and wide-reaching impacts on the economy, including impacts on monetary policy.
Welcome to Topic 10: Fiscal Policy. In this topic, you will learn about:
- Fiscal policy
- Impacts of fiscal policy.
These relate to the Subject Learning Outcomes:
- Interpret economic models, diagrams and tables to describe the economic situations.
- Explain how government policy influences microeconomic choices and macroeconomic outcomes.
- Analyse the economy as a whole using macroeconomic models.
Welcome to your pre-seminar learning tasks for this week. Please ensure you complete these prior to attending your scheduled seminar with your lecturer.
Click on each of the following headings to read more about what is required for each of your pre-seminar learning tasks.
Read Chapters 26, 28 and 34 of the prescribed text – Mankiw, NG 2016, Principles of microeconomics, 8th edn, Cengage Learning Custom Publishing.
Read the article, Mankiw, G & Summers, LD 1986, ‘Money demand and the effects of fiscal policies’, Journal of Money, Credit and Banking, 18(4):415-429.
Task: Examine the impact of increased monetary flow via tax cuts and record your answers to the following questions in your reflective journal.
- Why would the government give tax cuts at a particular time?
- Identify what economic conditions are present today in the Australian economy that is similar to those relied upon as the basis of tax cuts you identified.
You can access the reflective journal by clicking on ‘Journal’ in the navigation bar for this subject.
Read about the macroeconomics of fiscal policy:
- Kopcke, R, Tootell, GMB & Triest, RK 2005, Introduction: The macroeconomics of fiscal policy, 1st edn., MIT Press Books.
Task: Analyse the chapter and identify what happens with the factors of aggregate demand during the following:
- Expansionary fiscal policy settings
- Contractionary fiscal policy settings.
Record your responses in your reflective journal.
Watch the following video:
- Symonds, A 2021, 5 Observations about the 2021-22 Australian federal budget (Fiscal Policy for HSC Eco students), streaming video, YouTube.
Task: Identify the elements of the budget that may be aimed at improving quality of life and related social services. Take note of how far reaching the budget decisions can be across various areas. Record what parts of the government budget and its fiscal decisions surprised you. Add your responses in your reflective journal.
Read the news report on the 2021 May Budget:
- Evans, J 2021, Here’s a summary of the highlights in the 2021 federal budget, ABC News.
Task: Identify what was unexpected by the government regarding its fiscal policy and budget of 2020 compared to 2021. Note your findings in your reflective journal.
Read about the Multiplier Effect in the following article:
- Boyce, P 2021, The multiplier effect definition, BoyceWire.
Task: Follow the article's guidance on the multiplier effect and, if needs be, conduct more research on the effect formula. Complete the following tasks and record your answers in your reflective journal. Ensure you show your working out.
- Research three (3) different large-scale government investments – not recurrent investments but one-off big projects, such as new programs, equipment or infrastructure – with substantial budget investments, which will have been announced in annual Commonwealth Budget papers (by the Australian Parliament) at any time since 1990.
- For each of your chosen three large-scale initiatives:
- Identify the total funding amount the government has invested.
- Calculate the multiplier effect for each initiative.
- Describe the impact on inflation by each investment.
- Describe the impact on unemployment by each initiative.
There is a discussion forum activity for this topic, which will enhance your knowledge and give you the opportunity to interact with your peers. You can access the activity by clicking on the following link. You can also navigate to the forum by clicking on ‘ECO100 Subject Forum’ in the navigation bar for this subject.
- Topic 10, Forum activity 1: Inflation and unemployment
Read the following content.
Fiscal policy
Fiscal policy is primarily based on the well-established ideas of John Maynard Keynes (1883–1946), a British economist. Keynes believed governments could change national and international economic performance and, at times, should do so (Jahan, Ahmed & Papageorgiou 2014).
Governments implement fiscal policy primarily through spending or taxation, thus injecting or withdrawing cash flow, respectively. Governments aim to influence the economy by changing the tax system (individual and company rates) and the level of government spending on infrastructure, essential services and social welfare programs. Various governments worldwide take a lesser or greater role in the country’s economy. This is significantly influenced by the system of government and the type of political system. We are primarily considering Western countries based on a free market.
An annual national budget is a major part of a government's fiscal policy settings. Fiscal policy represents government spending policies that influence macroeconomic conditions, including inflation, unemployment, interest rates and the overall stability of the economy (aggregate demand). In the simplest terms, if the government wants to stimulate economic growth, an increase in government spending (such as on roads, bridges, hospitals and schools) will stimulate aggregate demand. Cuts to government expenditure will have a similar impact on demand, causing demand to contract as government cuts its spending (Encyclopedia Britannica 2019).
Through fiscal policy, governments attempt to control the economy, to improve the economy. This may be aimed at improving the standard of living for national citizens. The re-election cycle of a government also influences fiscal policy settings and prevailing macroeconomic conditions. Where a government directs its spending or tax changes will likely have particular economic effects based on such factors as the multiplier effect (Boyce 2021). The popularity of such fiscal policy decisions will also have a democratic effect on voters as well.
Impacts of fiscal policy
Fiscal policy can have significant targeted impacts on the national economy and an overall impact on the entire economy. It is essential to remember how numerous economic indicators, particularly the elements of GDP and the elements in the circular flow of an economy, can all have knock-on effects, which may be detrimental or adversely affect other aspects of the economy. Different fiscal policy changes will have different economic impacts, such as:
- Changes in savings
- Interest rates
- Growth in GDP
- Welfare funding.
The impact of changes in savings
In uncertain times, people get nervous about their employment. Their debt and discretionary spending are usually the first things to slow or be stopped. Consumers and households will often focus on holding their money as cash, paying down debt and saving the money they have. This is common during pandemic conditions when there is the threat of civil unrest or international conflict, during an energy crisis, or other global shocks.
The household saving rate in Australia declined steadily from the mid-1970s to the mid-2000s, falling below zero for the first time on record in the early 2000s. Declining household saving over this period was accompanied by a related strong growth in net borrowing (Freestone et al. 2002). More recently, with global COVID-19 pandemic conditions increasing unemployment and the economy slowing, in 2020 in Australia:
- Household savings in June were 10 % higher than in February and up 31 % from a low point in January
- Australian Bureau of Statistics data showed that the household savings rate in the March quarter jumped from 3.5 % to 5.5 % (Janda 2020).
The impact of expansionary fiscal policy on interest rates
As we discussed in previous topics with the circular flow of the economy, an injection of capital or money from the government will wash through the economy, causing additional impacts at each stage following where it is first invested. The Reserve Bank of Australia (RBA) is responsible for managing monetary policy, and a growth economy generally puts upward pressure on inflation. Demand begins to exceed supply and prices rise. So, reducing the level of money in the circular flow is one step the RBA can take to ease inflationary pressure. However, it is important to note that fundamentally the RBA and its Governor and Board are statutory authorities separate from the executive government of the day. In practical terms, the RBA sets interest rates as they determine best, not at the direction or request of the government.
The impact of tax cuts on growth (GDP)
Tax cuts are announced by the government, usually through the annual Federal Budget papers. Tax cuts apply to both corporate tax rates and individual tax rates. Unfortunately, tax rates do not often stay the same for long, although the cycles are measured in years, not unlike the elected term of a government.
It is important to note that when the government makes tax cuts, it expects individuals to behave a certain way with how they use their extra net pay. Unfortunately, individuals are free to choose and do not always spend the way the government would prefer.
The impact of increased government spending on welfare payments
The unemployed, veterans of military service and people living with a disability usually receive some form of social welfare payments from the government. Retirees have also historically been allocated a small pension payment to live off after working decades up until retirement age. The government sets these payment levels and can adjust them as part of fiscal policy.
In 2020, during the COVID-19 pandemic, the unemployment payments, pensioner payments and other social welfare payments were increased. These are methods for the government to invest in consumer household spending, which increases the level of economic activity. During the COVID-19 pandemic, household spending fell dramatically. So, the Australian Government supported economic growth by putting more money into welfare payments with the expectation that individuals and households would then use those payments to pay their essential bills and living expenses.
Knowledge check
Complete the following two (2) tasks. Click the arrows to navigate between the tasks.
Key takeouts
Congratulations, we made it to the end of the tenth topic! Some key takeouts from Topic 10:
- Fiscal policy is a big picture perspective, taking the whole of the economy and its impacts into consideration.
- Fiscal policy changes can have significant knock-on effects on an economy.
- Governments adjust fiscal policy in their attempts to manage the economy.
- Equally important to a national government is the fiscal policy impacts on factors including unemployment, inflation, interest rates and other factors that affect all citizens and the standard of living in the country.
Welcome to your seminar for this topic. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking ‘Join’ to enter the class.
Click here to access your seminar.
The learning tasks are listed below. These will be completed during the seminar with your lecturer. Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
In-seminar learning tasks
The in-seminar learning tasks identified below will be completed during the scheduled seminar. Your lecturer will guide you through these tasks. Click on each of the following headings to read more about the requirements for each of your in-seminar learning tasks.
Read the following two (2) articles, which look at the global fiscal policy responses of 2007 and 2020.
- Horton, M & El-Ganainy, A 2020, Fiscal policy: Taking and giving away, International Monetary Fund.
- Hudson, C, Watson, B, Baker, A & Arsoc, I 2021, The global fiscal response to COVID-19, Reserve Bank of Australia.
The article By Horton & El-Ganainy (2020) examines the fiscal policy impacts on aggregate demand during 2007. Whereas the article by Hudson et al. (2021) reviews the global fiscal response to COVID-19 in 2020.
Task: In a breakout room assigned by your lecturer, identify the similarities between the two (2) fiscal policy responses, taking note of the differences between 2007 and 2020. Analyse what the results are from each of the fiscal policies on demand.
In a breakout room assigned by your lecturer, compare and contrast different impacts of monetary policy and fiscal policy. Then, assess situations and desired outcomes where fiscal or monetary may be the more suitable economic policy to address economic conditions.
Welcome to your post-seminar learning tasks for this week. Please ensure you complete these after attending your scheduled seminar with your lecturer. Your lecturer will advise you if any of these are to be completed during your consultation session. Click on each of the following headings to read more about the requirements for each of your post-seminar learning tasks.
Read the following article, answer the questions and be prepared to discuss your answers during the consultation session.
- Reserve Bank of Australia 2021, Inflation and its measurement, Reserve Bank of Australia.
Task: Based on the premise that a central bank is separate and independent of a national government (for example, the Reserve Bank of Australia or the Federal Reserve in the USA), consider and identify how:
- The central or reserve back can influence inflation
- The government influence inflation.
Consider both increases or decrease to inflation in your answers.
Read the following research paper:
- Weinstock, LR 2021, Fiscal policy: Economic effects, Congressional Research Service, January 21.
Examine the section Potential offsetting effects to expansionary fiscal policy. In your journal, identify the economic and policy settings that can be deployed to mitigate undesirable impacts of fiscal policy.
Each week you will have a consultation session, which will be facilitated by your lecturer. You can join in and work with your peers on activities relating to this subject. These session times and activities will be communicated to you by your lecturer each week. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking 'Join' to enter the class.
Click here to access your consultation session.
Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
- Kelton, S 2021, The big myth of government deficits, streaming video, TEDMonterey.
- Chapter 4 of Gordon, RJ 2018, Macroeconomics, 12th edn., Pearson.
References
- Boyce, P 2021, The multiplier effect definition, BoyceWire, https://boycewire.com/the-multiplier-effect-definition/
- Britannica 2019, Fiscal policy, Britannica, https://www.britannica.com/topic/fiscal-policy.
- Evans, J 2021, Here’s a summary of the highlights in the 2021 federal budget, ABC News, https://www.abc.net.au/news/2021-05-11/federal-budget-2021-explainer/13339052
- Freestone, O, Gaudry, D, Obeyesekere, A & Sedgwick, M 2012, The rise in household saving and its implications for the Australian economy, Australian Government: The Treasury, https://treasury.gov.au/publication/economic-roundup-issue-2-2011/economic-roundup-issue-2-2011/the-rise-in-household-saving-and-its-implications-for-the-australian-economy
- Horton, M & El-Ganainy, A 2020, Fiscal policy: Taking and giving away, International Monetary Fund, https://www.imf.org/external/pubs/ft/fandd/basics/fiscpol.htm
- Hudson, C, Watson, B, Baker, A & Arsoc, I 2021, The global fiscal response to COVID-19, Reserve Bank of Australia, https://www.rba.gov.au/publications/bulletin/2021/jun/the-global-fiscal-response-to-covid-19.html
- Jahan, S, Mahmud, AS & Papageorgiou, C 2014, ‘What is Keynesian economics?’, Finance & Development, 51(3):53-54
- Janda, M 2020, Savings increase could either mean a deeper, longer recession or faster recovery, ABC News, https://www.abc.net.au/news/2020-06-09/bank-savings-go-up-raising-risk-of-deeper-longer-recession/12332250
- Kopcke, R, Tootell, GMB & Triest, RK 2005, Introduction: The macroeconomics of fiscal policy, 1st edn., MIT Press Books.
- Mankiw, G & Summers, LD 1986, ‘Money demand and the effects of fiscal policies’, Journal of Money, Credit and Banking, 18(4):415-429.
- Mankiw, NG 2016, Principles of microeconomics, 8th edn., Cengage Learning Custom Publishing.
- Reserve Bank of Australia 2021, Inflation and its measurement, Reserve Bank of Australia, https://www.rba.gov.au/education/resources/explainers/inflation-and-its-measurement.html
- Symonds, A 2021, 5 Observations about the 2021-22 Australian Federal Budget (Fiscal Policy for HSC Eco students), streaming video, YouTube, https://www.youtube.com/watch?v=JhAFtawO3Io
- Weinstock, LR 2021, Fiscal policy: Economic effects, Congressional Research Service, January 21, https://sgp.fas.org/crs/misc/R45723.pdf
