Expansionary Fiscal Policy

1. Canadian Federal Government Budget Cuts (1995)

  • Context: Facing a high national debt and significant budget deficits (reaching over 9% of GDP in the early 1990s) and at risk of credit rating downgrades, the Canadian government under Prime Minister Jean Chrétien initiated drastic fiscal consolidation.

  • Measures Implemented: Known as the "Program Review," these involved widespread spending cuts across federal departments, including defence, social programs, and transfers to provinces. Public sector wages were frozen or reduced, and some state assets were privatized.

  • Objectives: The primary goals were to eliminate the budget deficit, stabilize government finances, and reduce the spiralling debt-to-GDP ratio.

  • Economic Impact:

    • Positive: Achieved a budget surplus by 1997, leading to a significant reduction in the debt-to-GDP ratio over the following decade. Enhanced investor confidence.

    • Negative: Resulted in job losses in the public sector, reductions in public services, and potential short-term dampening of aggregate demand.

  • IB Economics HL Relevance: A strong example of contractionary fiscal policy aimed at fiscal consolidation; debates on the short-run costs (unemployment, reduced AD) vs. long-run benefits (fiscal sustainability, lower interest rates for private investment).

2. Austerity Measures in Greece (2010-2018)

  • Context: At the heart of the Eurozone debt crisis, Greece faced an unsustainable sovereign debt burden (exceeding 170 ext{%} of GDP), large budget deficits, and a lack of market access for borrowing. This led to intervention by the "Troika" (International Monetary Fund - IMF, European Central Bank - ECB, and European Commission - EC).

  • Measures Implemented (Under Bailout Agreements): A series of severe austerity packages were mandated in exchange for bailout funds to prevent a default and potential exit from the Eurozone.

    • Deep cuts to public sector wages and pensions (e.g., reductions of 20-40%).

    • Significant increases in various taxes, including Value Added Tax (VAT), property taxes, and income taxes.

    • Extensive privatisation of state-owned assets (e.g., ports, electricity grids).

    • Labour market reforms, including reductions in the minimum wage and easier dismissal procedures.

  • Objectives: Restore fiscal sustainability, reduce the public debt-to-GDP ratio, regain investor confidence, and improve Greece's competitiveness within the Eurozone.

  • Economic and Social Impact:

    • Negative: Prolonged and deep recession (GDP contracted by over 25%), extremely high unemployment (youth unemployment exceeding 50% at its peak), significant social unrest, political instability, and a humanitarian crisis. The large fiscal multiplier meant that spending cuts disproportionately reduced aggregate demand.

    • Critiques: Many argued the austerity was pro-cyclical, worsening the recession and making debt reduction harder due to shrinking GDP.

  • IB Economics HL Relevance: Illustrates extreme contractionary fiscal policy, the challenges of fiscal consolidation during a crisis, the role of external creditors, and the social costs of austerity. Debates on the size of the fiscal multiplier and the impact of national sovereignty within a monetary union.

3. European Union Stability and Growth Pact (1997)

  • Context: Established to ensure fiscal discipline among EU member states, particularly those adopting the Euro, to prevent excessive deficits and debt that could undermine the stability of the common currency and monetary policy.

  • Key Rules (Fiscal Targets):

    • Budget Deficit: Governments must aim for a general government deficit no greater than 3 ext{%} of GDP (G - T ext{ (Budget Deficit)} < 3 ext{% } GDP).

    • Government Debt: Total government debt must not exceed 60 ext{%} of GDP (National Debt < 60 ext{% } GDP) or must be decreasing towards this reference value at a satisfactory pace.

  • Enforcement Mechanisms:

    • Preventive Arm: Multilateral surveillance warns countries of potential deviations from fiscal targets.

    • Corrective Arm (Excessive Deficit Procedure - EDP): Initiated if a member state breaches the 3 ext{%} deficit threshold. Can lead to financial penalties for Eurozone members.

  • Reforms: The Pact was strengthened after the 2008 financial crisis and Eurozone debt crisis with the "Six-pack" (2011) and "Two-pack" (2013) legislation, enhancing surveillance and enforcement, especially for Eurozone members.

  • IB Economics HL Relevance: Demonstrates attempts at fiscal policy coordination in a monetary union, the concept of fiscal rules, and their potential pro-cyclical effects (forcing cuts during recessions). Discussion on the trade-off between fiscal discipline and national macroeconomic stabilization.

4. U.S. Budget Control Act (2011)

  • Context: Following the Great Recession (2008) and significant stimulus spending, the U.S. faced a rising national debt and persistent high deficits. Political debates over the debt ceiling led to the need for a legislative solution to reduce future spending.

  • Measures Implemented:

    • Imposed statutory caps on discretionary spending (both defence and non-defence) for ten years.

    • Established a Joint Select Committee on Deficit Reduction (dubbed the "supercommittee") tasked with identifying at least 1.2 trillion in additional spending cuts or revenue increases over ten years.

    • Included a sequestration mechanism: Automatic, across-the-board spending cuts if the supercommittee failed to reach an agreement (which it did).

  • Objectives: Address concerns about the national debt, reduce the federal deficit, and prevent a potential government default.

  • Economic Impact:

    • Fiscal Contraction: Led to significant reductions in government spending, particularly through sequestration, which acted as a fiscal drag on the economy during a period of ongoing recovery.

    • Uncertainty: The threat and implementation of automatic cuts created policy uncertainty, potentially deterring investment.

  • IB Economics HL Relevance: Illustrates legislative attempts to control government spending, the concept of fiscal anchors, and the potential negative impact of automatic, blunt spending cuts (sequestration) on economic growth and aggregate demand. Highlights political constraints on fiscal policy.

5. Australian Government’s Austerity Measures (2014-2017)

  • Context: As the commodity (mining) boom ended, Australia faced declining government revenues and persistent budget deficits, challenging the goal of returning to a budget surplus.

  • Proposed Measures (Under Prime Minister Tony Abbott): The government proposed a range of austerity measures intended to reduce the budget deficit and restore fiscal sustainability, including:

    • Cuts to public services (e.g., funding for Medicare, universities).

    • Reductions or changes to welfare programs (e.g., unemployment benefits, pension eligibility).

    • Increases in certain taxes and fees (e.g., co-payments for general practitioner visits).

    • Freezing of foreign aid increases.

  • Challenges and Impact: Many of the more controversial proposed cuts faced significant public backlash and strong political opposition, leading to them being scaled back or blocked in the Senate. This demonstrated the political difficulty of implementing deep austerity measures in a stable democracy.

  • Objectives: Fiscal consolidation, returning the budget to surplus, and reducing future national debt.

  • IB Economics HL Relevance: A case study of government attempts at contractionary fiscal policy, highlighting the political economy challenges and social implications of austerity. Discusses how weakening aggregate demand (due to cuts) can conflict with long-term supply-side goals (e.g., human capital investment through education and health spending).