Jim Tsao Yr12 Economics Assessment Evaluate the effectiveness of fiscal policy in achieving Australias economic objectives Australian

governments over recent decades have traditionally aimed to achieve three major objectives of economic growth, internal balance, and external balance within an economy. Together, these three objectives aim to sustain national economic growth while maintaining low inflation as well as limiting the size of foreign debts and liabilities. The level of economic growth in an economy is never constant however and is subject to the ups and downs of the international business cycle. Government macroeconomic management is designed to minimise these fluctuations through influencing demand, so that sustained growth could be possible, with low inflation and low unemployment. However, due to its demand-side nature, macroeconomic policies cannot be used exclusively, and therefore are used in conjunction with the supply-side influencing microeconomic reforms. The main role of macroeconomic policy is to manage the business cycle or the change in the level in economic activity. The level of economic activity is never constant. Economies are subject to the ups and downs of the economic cycle caused by the changes in the level of aggregate demand and supply. Government macroeconomic management is designed to minimize these fluctuations so that economies experiences low rates of inflation and unemployment and relatively stable economic growth. Macroeconomic management can be defined as the use of government policies to influence the economy with the aims of reducing large fluctuations in the level of economic activity and achieving certain economic goals. Government policies can help stabilize the level of economic activity and growth by smoothing the peaks and troughs of the economic cycle. This is another reason why macroeconomic are also referred as counter cyclical policies. During periods of fast economic growth, it may be necessary to reduce the level of economic activity to avoid excessive inflation or a blowout in the current account deficit (CAD). Government can increase the level of tax, reduce spending or raise interest rates in order to reduce the level of economic activity. On the other hand if the economy has experienced a sustained period of economic growth, governments may use macroeconomic policy to stimulate economic activity and raise the level of aggregate demand. This may be done through increased government spending, tax cuts and the reductions of interest rates. In influencing demand and supply in an economy, the government uses fiscal policy as well as working in conjunction with monetary policy and microeconomic reform to achieve key economic objectives. Fiscal policy essentially involves the use of the governments budget in order to influence the economic objectives by varying the amount of government spending and revenue, in turn altering the level of economic activity, with a fiscal surplus, fiscal deficit, or a balanced budget. As the budget can influence the economy, in turn, the economy can

Jim Tsao Yr12 Economics Assessment influence the budget outcomes. This budget outcome is formed through both the cyclical component, where automatic stabilisers such as tax receipts and government spending through transfer payments adjust accordingly to the state of the economy, and also through the structural component, where discretionary, proposed changes by the government such as reduced spending deliberately alter economic activity. As the budget can influence the economy, in turn, the economy can in influence the budget outcomes. The budget outcome is formed through both the cyclical component, where automatic stabilizers such as tax receipts and government spending through transfer payments adjust accordingly to the state of the economy, and also through the structural component, where discretionary proposed changes by the government such as reduced spending deliberately alter the economic activity. Automatic stabilisers play a counter-cyclical role within the budget, but are rarely strong enough to counter the full effects of the cycle, and so discretionary fiscal policy will always be relied upon heavily. Over a short-term period, an expansionary fiscal stance is employed when the government aims to stimulate growth. This is done through increased government spending and reduced taxation, causing a multiplied increase in consumption and investment according to Keynes multiplier process. Similarly, a contractionary fiscal stance is undertaken to slow the economy down, and also to limit foreign liabilities and Current Account Deficit (CAD). The level of income distribution and the direction of resource use can also be attributed somewhat to the results of a fiscal stance. The most significant short term impact of fiscal policy is how it affects economic activity. The impact of fiscal policy on economic growth can be described as expansionary or contractionary. An expansionary stance is one where the government is planning to increase the level of economic activity in an economy. This can occur through either a reduction in taxation revenue or an increase in government expenditure, creating either a smaller surplus or a larger deficit than in the precious year. This can lead to a multiplied increase in consumption and investment and stimulates aggregate demand which increases economic activity. A contractionary stance is one where the government is planning to decrease the level of economic activity in an economy. This can occur through either an increase in taxation revenue or a decrease in government expenditure, creating a smaller deficit or a bigger surplus than in the previous year. This contraction leads to a multiplied decrease in consumption and investment, dampening aggregate demand, which decreases economic activity. Although a fiscal policy does achieve in helping the economy for a short period of time by affecting the elements of aggregate demand, specifically investment and consumption, however it does have several problems that hinder its effectiveness. On the one hand an expansionary fiscal policy by decreasing taxation and increasing government spending the fiscal policy will probably achieve in increasing aggregate demand. This will happen since the decrease in taxation will increase peoples disposable

Jim Tsao Yr12 Economics Assessment income and consequently depending on the marginal propensity to consume the domestic consumption of an economy which in turn will increase aggregate demand. Similarly the government by increasing spending in all sectors of its economy it will increase investment which in turn may lead to an increase in aggregate demand. This is an effective way to combat economic problems such as unemployment and recession. On the other hand if a government wants to eliminate recession it will have to pursue a contractionary demand side policy. This policy will increase taxation thus decreasing the citizens disposable income thus in turn reducing consumption which will reduce aggregate demand which will in turn reduce inflation. On the other hand it will decrease government spending thus decreasing investment which will again reduce aggregate demand and thus in turn reduce inflation. However these policies arent always very effective for several reasons. Firstly fiscal policy cant be effective if consumption isnt effective to tax changes in other words if there is a high marginal propensity to consume. What this will mean is that no matter how high the government raises taxes the people will still insist on spending as much as they previously did thus not decreasing domestic consumption. On the other hand if there is low marginal propensity to consume no matter how low the government drops the tax domestic consumption wont increase and thus domestic consumption wont increase. Moreover a fiscal policy could lead to the crowding out effect. In the case of resources crowding out this indicates an increase in reward for the factors of production. This happens in the case of an expansionary fiscal policy government spending on public and merit goods as a result the government increases demand for specific factors of production. This increased demand will lead to increases in wages, rent and interest rates. In the case of financial crowding out increased government spending will lead in an increase in demand to borrow money so as to finance this spending. As a result there will be an increase in interest rates which in turn may discourage investment from private firms. Another problem that may occur is that the government may over or under estimate the problem and thus impose a non effective fiscal policy since it will either increase demand too much or too little. This may occur due to information problems seeing that information is sometimes difficult to collect on the exact position of the economy at any moment and thus may make false estimations on the extent to which the policy should be dragged. There is also the issue of time seeing that in order for the fiscal policy to be constructed this may take some time and by then the situation will be altered thus the policy wont be as effective. Finally there is the issue of the fiscal drag that may make fiscal policies ineffective. This happens because if the government keeps increasing government spending with taxation levels remaining stable the government may move into recession and a deflationary gap might emerge. This can be explained by the fact that people earning higher income due to an increase in government spending will move to a higher income bracket and pay higher taxation something that will reduce consumption on their part and make the economy slowdown instead of growth.

Jim Tsao Yr12 Economics Assessment The use of fiscal policy can have a significant impact on the economic objectives such as economic growth, inflation and distribution of income and wealth. Government policies can influence inequality throughout society in direct and indirect ways. Fiscal policies generally have the most impact through changing the levels of government benefits, taxation, wages and salaries. However, the side effects of policies pursued for other purposes, such as microeconomic reform, can also affect inequality. Changes in government spending and taxation policies have the most direct impact on inequality in Australia. Overall, government intervention tends to reduce income inequality by taxing the wealthiest groups more heavily and redistributing income to lower socio-economic groups. As income rises, so too does the level of taxation. This occurs because Australia has a progressive tax system, with higher marginal tax rates for higher income levels. Government benefits to the unemployed, low income earners and the elderly, and the provision of government services such as health, education, and housing are the primary mechanism for reducing disadvantage in Australia. The 2009-10 Budget included a range of decisions that may redistribute income from higher to lower income earners. On the revenue side of the Budget, that changes to the income tax system, including the expansion of the Low Income Tax Offset, might reduce the tax burden on lower income groups. On the expenditure side, the large boost in pension entitlements provides a permanent increase in income levels to some of the lowest income earners in the economy. At the same time, the means- testing of family payments and the reduction of the private health insurance rebate for higher income earners may also contribute to reducing income inequality. The government is able to use macroeconomic polices the rate of economic growth. The use of fiscal policy can help achieve certain economic objectives and also achieve sustainable economic growth. If the government wants to increase the level of economic growth, it can reduce taxation, increase expenditure or do both. This would increase the level of injections relative to leakages and therefore cause an upturn in the level of economic growth. On the other hand, economic growth would be constrained if tax receipts were increased or government expenditure was reduced. Generally, a fiscal policy is more effective in stimulating growth during a downturn than slowing down an economy that is growing fast. Since the large fall in inflation during the recession of the early 1990s, the government and the Reserve Bank have sought to maintain a low level of inflation in the Australian economy. Monetary policy has been the main tool used to achieve low inflation, but other parts of the policy mix are used to address price pressures in the economy. Fiscal policy plays a supporting role in conjunction with monetary policy in maintaining low inflation. If the government increases revenue and decreases spending, it would reduce demand pressures in the economy and can reduce demand-pull inflation. Example, in the 2008-09 Budget, the government increased the size of its forecast budget surplus with the objective of minimizing inflationary pressures in the economy by reducing public demand. In 2009-10, budget strategy had completely changed, with the Government increasing spending to stimulate the economy, and inflation being a much

Jim Tsao Yr12 Economics Assessment lower priority. Fiscal policy settings that support the low-inflation objective may also reduce the need for higher interest rates to combat an inflation challenge. Macroeconomic policies have traditionally been effective in impacting the short-term demand economy, and over the last decade, fiscal policy has played a key role in the policy mix, where the government has used this aim of policy to improve Australias national savings and to control government public debt in order to keep external factors under control and maintain external stability, providing opportunities for economic growth. In short, the government has previously used fiscal policy to achieve external balance, however, private sector savings and investment decisions are now better bases, as a result of more successful microeconomic reform, and now the government acknowledges Australias position as a capital-importing nation, inviting foreign savers to invest within Australia, causing capital surpluses and by definition, current account deficits. Due to the current favourable position of the economy, the Howard government in the past has quietly abandoned the use of fiscal policy to achieve external stability, as it is no longer among the governments current policy objectives. Instead, the government ensures that it makes no contribution, through private sector borrowings and public sector debt, to the CAD. In doing so, the government now aims for the achievement of fiscal balance on average over the economic cycle. While proving successful in controlling negative influences of demand, the governments macroeconomic policy mix, in the broadest sense, has had limited impact on Australias structural problems, and that is why microeconomic reform has come into prominence over the last decade, in helping macro policies deal with supply-side constraints to help Australias international competitiveness. But overall the use of macroeconomic policies such as fiscal policy have major impacts on the economy and have a good effectiveness in achieving key economic objectives.