Sac 6 - Monetary + Budget Policy

Budgetary Policy

• government revenue and expenses

Monetary policy

• manipulating interest rates

Purpose of AD policy’s & what happens in a contraction/expansion

• both budgetary and monetary policy work [in different ways] to smooth out the level of AD and the business cycle to prevent booms and busts [steep drops and peaks]

• Contraction: decrease i/r, decrease taxes, increase spending - smooth economic activity

• Expansion: increase I/r, increase tax, decrease spending - Smooth economic activity

3 main elements to the budget

• budget revenue [TAX]

• budget outlays [Spending]

• the overall budget outcome [Surplus/Deficit]

Sources of Government Revenue: direct Tax

• majority of income for the government - collection of tax directly from individuals or businesses on INCOME/PROFITS

• The tax payer pays tax straight to the government

• eg. Income tax, corporate tax

Sources of Government Revenue: Indirect Tax

• Tax levied on the buyers/sellers of G+S, not directly on incomes/profits

• the tax is collected by the producer/seller then passes onto gov

• eg. GST, exercise tax

Sources of Government Revenue: Sale of gov assets or revenues from gov business

• sell business to private sectors to create revenue for the government eg. Telstra

• Gov business if make profits = gov revenue

Three types of Sources of Government Revenue:

• direct Tax

• indirect Tax

• the sale of gov assets or revenue from gov businesses

Types of Taxes: Progressive tax

• the proportion of tax paid out of total income increase’s as income rises

• the more a person earns, the larger % of tax that is levied on their income

• eg. Income tax

Types of Tax: Regressive Tax

• the proportion of tax paid out of income decreases as income rises

• the % of tax paid is higher for lower income earners than higher income earners

• eg. GST

Types of taxes: Proportional tax

• A form of taxation in which the proportion of tax paid out of total income is constant amongst all taxpayers

• eg. Company Tax rate is 30%

3 types of tax

• progressive tax

• regressive tax

• proportional tax

Types of government expenses: Current Spending [G1]

• Day to day operational spending by the government [ongoing cost of running the gov]

• have a current benefit eg. Staff

Types of government expenses: Capital spending [G2]

• investment spending by the government into physical assets

• have a future benefit

• eg. Infrastructure, schools, roads

Types of government expenses: Transfer payments

• one way payments [not in exchange for anything]

• redistribution from one area to another

• eg. Age pension, centrelink

Types of government expenses

• Current spending [G1]

• Capital spending [G2]

• Transfer payments

The Budget Outcome

• the budget outcome refers to the difference between government receipts [revenue] and outlays [expenditure] in a given year

• Budget outcome = receipts - outlays

Balanced Budget, Budget Deficit, Budget Surplus

• Balanced = Receipts = outlays - neither an expansionary/contractionary stance - had little affect on AD

• Deficit = receipts < outlays - net injection into the economy therefore an expansionary effect, boosting AD and economic growth

• Surplus = Receipts > outlays - net leakage into the economy - contractionary effect, slow AD and inflation during a boom

The underlying Cash balance [Headline + Underlying]

• Headline: all revenues & expenses on a cash accounting basis over the finical year

• Underlying: Removes both receipts and payments relating to investment in finical assets [non recurring] eg. repayment of a loan

underlying cash balance as a % of GDP

• measures the size of the underlying cash balance as a proportion of GDP [size of economy] - eg. 20m deficit for a 1b economy = 2% deficit

• lower % = economy is getting bigger

• if deficit grows in line/or slower rate then GDP = good

• if deficit grows faster then GDP = bad

Financing a deficit

• the gov cant/wont go back to increase revenue [Increase Taxes]

  or decrease outlays [spending] as that is changing the budget

• therefore they finance it through borrowing [selling bonds] to local investors, oversea investors, to the RBA

Utilizing a Surplus

• If the government runs a surplus they can

• pay off debt: by repaying bonds, must be done by utilizing the surplus

• invest: in future fund - pool of money that is invested and put away for future gov spending [Shares/Property]

• or save

The relationship between the budget outcome and level of gov [public] debt - Deficit

• expenses are greater then their revenues over a financial year

• they need to finance this by selling bonds = increase the level of gov debt

• this increase in debt = an expense for the gov - this therefore increases the size of future deficit [ceteris parabis]

• Any time the gov is in a deficit = DEBT is rising

The relationship between the budget outcome and level of gov [public] debt - Surplus

• means their revenues are greater then their expenses over a financial year

• they may choose to pay down debt with this surplus, reducing the amounts of public debt

The role of automatic stabilizers in influencing debt and stabilizing the business cycle + what are the two stabilizers and what do they do in an expansion/contraction

• built in stabilization mechanism - that speed up the economy when growth is to slow, slow down when growth is to high, without gov intervention

• REVENUE [1st stabilizer] - income tax revenue increases in an expansion slows AD [increase leakages] and decrease in an contraction [decrease’s leakages = slows drop in AD]

• welfare payments [2nd Stabilizer] - will decrease in an expansion [decrease injections] slows AD - yet they’ll increase in a contraction [increasing injections into the economy - slows drop in AD]

• Smooths out the business cycle without gov intervention

Discretionary stabilizers

• deliberate policy decisions made by the government to change tax rates/gov spending in response to economic conditions; aimed to help smooth the business cycle out and help stabilize AD

discretionary stabilizers influence on AD/business cycle [in recession and boom]

• Recession: - decrease tax rates = reduces leakages stimulating AD

  - increase gov spending = increase injection stimulating AD

• Boom: - increase tax rates/allow brackets to increase: increases leakages - slowing AD

  - decrease/slow gov spending - decrease injections therefore decreasing AD

• If not reversed following recovery can lead to ongoing strucutal budget deficits

Impact of automatic/discretionary stabilizers on outcome/debt

• during a contractions stabilizers will - increase deficit / decrease the surplus

• during an expansion they will: increase the surplus / decrease the deficit

Stance of budgetary policy [Outcome determines the stance]

• the ‘stance’ signals the gov intention to use the budget to impact economic activity and the level of AD

• if the budget is contracting the level of AD/eco activity must be in/moving to a surplus [as S= contractionary]

• if the budget is expanding the level of AD/eco activity the budget must be in/moving to a deficit [as D = exapansionary]

Budgetary stance initiatives over the past two years and their affect on the 3 goals + LS: 3 billion dollar energy bill relief fund

• 300$ rebates to 10m households and 1m small businesses, which increases availability of disposable income - increasing C

• by expanding AD, profit seeking firms respond by raising production, leading to an increase in GDP growth aiding SSEG

• due to this change in production levels theyll be an increase in the DDFL, increasing labor market conditions, aiding goal of FE

• this increase in AD, leads to higher inflationary pressures, hindering goal of price stab

Budgetary stance initiatives over the past two years and their affect on the 3 goals + LS: 1.1 billion for skills and training investment

• increase the availability of workers/jobs, which increases the DI of households - increasing C - increasing AD

• this creates an expansion in AD in which profit seeking firms respond by increasing production…

• due to this change in production levels - there will be an increase in the DDFL

• this increase in AD leads to higher inflationary pressures…

2 strengths of using BP to affect AD and influence the achievement of 3 goals

• short term impact lag: the budget impacts the level of AD relatively quickly, Tax/spending changes once implemented will quickly impact the level of AD

• discretionary policy’s can precisely target specific areas of great weakness: this means that by changing the composition/structure of expenses or revenues, the gov can target areas of weakness

2 weaknesses of using BP to affect AD and influence the achievement of 3 goals

• the budget is subjected to political bias/constraint as it is highly politicized - leads to budgets being used for political purposes rather then economic

• the budget has a long term implementation lag - as it can take a long time for the budget to be implemented due to having to be voted by both houses

Role of the RBA with respect to monetary policy

• The RBA is independent of the gov - and their role is to achieve the 3 domestic macroeconomic goals

Conventional monetary policy

• the RBA targets the cash rate commercial banks borrow and lend to one another, which in theory banks then pass these cost’s onto consumers

How does the RBA target the cash rate

• in the overnight money market, through the banks ES accounts, whereby the RBA intervenes by placing rates in the policy interest rate corridor

• The floor [deposit rate]: this is the rate the RBA will pay banks who have a surplus in their ES - the deposit rate = CRT - 0.10

• The celling [lending rate]: the rate the RBA will charge banks who have a deficit in their ES account - the lending rate = CRT + 0.25

• The cash rate target is changed by simply moving the corridor up and down

Things to consider in the overnight money market [EQ, cash rate target, actual cash rate]

• EQ price is the market cash rate for borrowing/lending [the cash rate]

• the cash rate target = quoted by the RBA

• the actual cash rate = where D/S intersect

Transmission mechanism of MP - and affect on level of AD - the four channels

Savings and investment channel

• ‘cost of credit’ - reward for saving and cost of borrowing, therefore impacts the decision to save vs borrow and spend

• affects both households and businesses eg. increase in IR = increased reward for savings

Transmission mechanism of MP - and affect on level of AD - the four channels

Cash flow

• households/businesses who have existing debt [through variable interest rates] if the RBA changes the IR, payments change affecting incomes and business cash flow [C+I]

• eg. increased Interest repayments decreases income for H+B

Transmission mechanism of MP - and affect on level of AD - the four channels

Exchange rate

• relative IR, determines where investors will invest their money, they find the country with the highest relative interest rates

• this will change the D for AUD, the exchange rate and X-M

• eg. increase in AUS I/R increase D for AUD - apperciation

Transmission mechanism of MP - and affect on level of AD - the four channels

asset price channel

• lower IR increases price of assets, as there is greater access to credit = makes ppl feel wealthier = an increase in Consumer confidence = increase C+I = increase AD

The stance of monetary policy (neutral/contractionary/expansionary)

• Neutral: in the middle of contractionary and expansionary there is a rate that has no impact on AD (around 3%)

• expansionary: below 3%

• contractionary: above 3%

Stance of MP over the past 2 years and affect on IR

• milidy contractionary - increased to 4.35 due to countering high inflationary pressures following covid

• this slowed AD, reduced inflation, reduced growth and aimed for moderate full employment

Strengths of using MP to affect AD and achievement of the domestic macroeconomic goals

• no political bias/constraints: make decision purely on economic conditions even if these are not popular

• short implementation lag: the RBA meets 11 times a year to make decision, which gives them flexibility to wait and see for key data before making decisions

Weaknesses of using MP to affect AD and achievement of the domestic macroeconomic goals

• long impact lag: takes time for changes in the CRT to come into effect - this is due to fixed mortgage rate such long lags means there is a greater chance monetary policy is pro cyclical [with the cycle]

• is blunt: changes in the I/R affects the whole economy and therefore the policy changes cannot address areas of concern