Economic functions of the Australian Government

15.3 Reallocation or resources

 The government allocates resources by directing resources towards the
production of goods it desires, and away from less desirable goods.
 The government does this by:
 Influencing the way businesses and consumers behave in the market
through taxation or spending measures
 Producing goods or services itself (e.g. public goods)
Taxation
 Taxes add costs to good, thus diverting resources away from a certain
types of economic activity
 Similarly reduced rate of tax, or tax concessions may attract resources
towards a specific sector.
 Governments use direct and indirect taxes to reach there resource goals
 Direct taxes are those that have to be paid by the person they are levied
on. E.g. personnel income tax, capital gains tax and company tax
 Indirect taxes are attached to the good or service and can be passed on.
E.g. GST is levied on the seller but passed onto the consumer in the form
of a higher price.
 Government have used indirect taxes on items such as tobacco to divert
resources away from production. The increased prices on cigarettes and
Medicare for smokers deters new smokers and encourages existing ones
to quit.
Spending
 The gov'ts goal is to redress a failure of the market to provide an
allocation of resources that fits the community's broader needs and
wants by spending directly on a particular sector or influencing the
decisions of consumers and businesses e.g.
 Funding for the arts which may otherwise be unprofitable
 Grants for start of businesses or new growth industries that, without
proven trach record, might lack access to finance
 Subsidies for telecommunications companies such as Telstra to provide
broadband services in regional areas where those services will not be
profitable
 Cash payments to private employment search businesses, which find
jobs for unemployed people
 The gov't relies heavily on trying to influence he decisions of private
businesses ans consumers as they make u most of the economy, e.g
 subsidies for venture capitalist may encourage additional investment
from the private sector.
Government provision of goods and services
 Governments sometimes involve themselves in directly in the
production process to achieve a better allocation of resources. E.g.
roads, railways, public transport, postal etc.
 The belief is the govt can provide cheaper goods and services to a larger
number of people as they are not aimed at making profit.
 This attitude changed as govts proved to be inefficient in many sectors
and this inefficacy caused increased costs for consumers, dur to no
incentive to make profit.
 Privatisation is a regular occurrence now
public sector.
· Gov’t intervening in the economy to provide new infra structure due to market failure, i.e. large up-
front investment and the long-term returns, which may be 15, 20 25-year time span.
· Budget measure $24.5 billion in this budget ($75bn increase in gov’t infra-structure investment
over
10 years) Re allocating resources,capital, land, labour and enterprise.
· Examples: NSW: Western Sydney North – South rail link / Coffs Harbour bypass / Port Botany
freight
duplication = $1.4bn ,VIC: Melbourne airport – city rail link = $5bn,WA: Infrastructure package /
Perth
Metronet Rail = $3.2b
· Better targeting of R&D tax concessions to save $2 bn over 4 years, but$1.3bn to fund
revolutionary genomic
research projects investigating medicines
· Explain the Multiplier effect of these investment
· Draw PPF
/ AD diagram

15.4 The redistrubtion of income

 Australia has had a reduction of government intervention in the

economy since the 80's, causing wealth and economic growth at the
expense of social inequality (income inequality)
Taxation
 How the ART changes as an individuals income increases indicates
whether the tax is:
 Progressive tax: Higher income earners pay a greater proportion of there
income as tax then lower income earners. Personnel Income tax in
Australia is a progressive tax
 Regressive tax: Higher income earners pay a lower proportion of there
income as tax then lower income earners. GST is a regressive tax.
  Proportional tax: All income earners pay the same proportion of there
income as tax. Company tax in Australia is a proportional tax
Social welfare payments
 The commonwealth redistributes taxation revenue to lower income
earners via social welfare payments
 Account for 1/3 of govts expenditure each year
 Payments are means tested, meaning high income earners are ineligible,
highlighting the design to reduce income inequality
 Examples include unemployment benefits, family benefits and various
pensions (elderly, disabled and single parents)
· 18/19 Tax cuts aimed at those on low and middle incomes , up to $90,000 pa. Average tax payer
inn tis range
will gain an extra $530 pa
· Initial tax cuts are skewed towards lower income earners, BUT 10-year package results in larger
dollar saves
for higher income earners
· Proposed reforms reduce the progressiveness of the tax system which, other things being equal,
wil incesaes
income inequality in Australia over the longer term.
· However, some mesures in the Budget are desined to improve inequality e.g. new public hospital
funding of
$980m over 4 year,Widened Pharmaceutical Benefits Scheme listings, costing$750m over 4 years,
14,000
extra home care packages aimed at allowing the elderly to stay in their own home longer

Overall economic activity

Link to resource allocation and income distribution.
· AD = C+I+G+(X-M)
· Give growth figures / forecasts in Budget, Growth going up from 2.6% to 3% over next 4 years,
unemployment to fall from 5.5% to 5.2%, inflation steady at 2% over 4 years, Show with AD graph
· Infra-structure investment, plus multiplier effect should increase growth and lower unemployment
· Perosonal and Corporate tax cuts and the impact on future economic growth
· Continuation of company tax cuts of 27.5% rate for all businesses,Reduction in rate from 27.5% to
25.0% in
2026/27

Federal budget
The budget process 16.1
 Fiscal policy is the macroeconomic policy that involves the use of
taxation and spending powers through the commonwealth budget in
order in order to achieve economic objectives
  Objectives include:
 Stabilising the level of economic activity
 Maintaining low inflation
 Reducing the level of unemployment
 Achieving goals relating to the distribution of income
 Budget is an official document presented in may each year outlining
govts revenue and expenditure plans by varying it expenditure (G) and
revenue (T) to reach goals.

Types of budgets
 Balanced budget: Planned govt revenue(T) = planned government
expenditure(G)
 Budget surplus: Planned govt revenue > planned government
expenditure
 Budget deficit: Planned government revenue < planned government
expenditure
 The changes in a budget outcome from one year to another indicate the
stance, these include:
 An expansionary fiscal policy stance: Govt may reduce taxation revenue
or increase expenditure (or both) creating a smaller surplus or larger
deficit than previously. Its aim is to increase the level of economic
activity by stimulating AD, in turn reducing unemployment but running
the chance of increasing inflation if growth is to quick.
 A contractionary fiscal policy stance: Govt may increase taxation
revenue of reduce expenditure(or both) creating a smaller deficit or
larger surplus than previously. Aiming to reduce level of economic
activity by dampening AD, in turn reducing inflation but increasing
unemployment if demand is reduced to much ad firms do not need as
much resources.
 A neutral fiscal policy: No change in outcome from previous years level,
therefore no affect on AD or economic activity.
Automatic stabilisers
 Automatic stabilisers are policy's that that operate automatically to
counterbalance the level of economic growth and stabilise the economy.
These operate in two situations:
 An increase in economic activity: When economy is growing, income
levels increase leading to rises in taxation revenue while unemployment
falls, reducing expenditure on welfare. This would trigger a smaller
deficit or larger surplus, leading to an automatic contraction in AD thus
having a stabilising affect without any govt intervention
  A decrease in economic activity: When in recession, income levels fall
leading to less taxation revenue, unemployment rises leading to more
expenditure on welfare. This leads to a smaller surplus or larger deficit,
therefore stimulating AD without govt intervention.

Revenue and expenses

Common wealth government revenue

 94% of government revenue comes from taxation, sources of taxation
revenue are divided into direct taxes (e.g personal income and company
tax) and indirect taxes (e.g GST)
 Income tax (Imposed on individuals and companies) makes up almost
70% of total govt revenue
 Personnel income tax : makes up 47.2% of all government revenue, Is
under the PAYG system as tax payments are regularly deducted from
pay cheques of wages and salary earners. People who are self employed
and make money off investments also pay income tax through this
system.
 Company tax accounts for 17.9% of govt revenue, a flat rate of 30% is
taxed from the net profit of all public and private enterprises before
being distributed to shareholders, SME's tax dropping to 25% through
new budget. Businesses also pay fringe benefits for all non cash benefits
the provide for employees (company cars, dinners) this accounts for 1%
of revenue.
 Superannuation contributes 2% of govts revenue. Its contribution has
substantially grown in the past and this trend is forecast to continue.
 GST is the main indirect tax in Australia, a 10% tax rate is applied to most
items sold excluding basic foods. It makes up 15% of all tax collected and
it automatically allocated to state and territory governments
 Excise and custom duties (Imposed on producers of certain goods) make
up 8% of govt revenue. They are applied to relatively inelastic items such
as petrol, diesel Tabaco and alcohol as the increase in price will only
cause a small contraction in demand.
 Other tax revenue , 2% of govt revenue. Covers a whole range of taxes,
charges, fees and fines imposed on the Australian government such as
passport fees
 Non-tax revenue account for 6% of govt revenue, include profits from
government enterprises as well as interests, dividends and royalties paid
to the government.

Commonwealth government Expenditure

  Major spending items include:
 Social security and welfare: largest expenditure with 35.3% of overall
spending. This category represents transfer payments (payments aimed
at redistributing income from taxpayers to welfare recipients such as
elderly and unemployed)
 Education: the commonwealth govt provides education funding to unis,
vocational and training providers, as well as govt and non govt primary
and secondary education.
 Health: Primarily dealt with by state govts but the commonwealth
govt funds Medicare, pharmaceutical befits and funds public hospitals
 Protecting the environed and promoting ecologically sustained
develpments: govt invest in clean energy and low carbon emission
technologies, energy efficient measures and better management of
water resources.

· Borrowers are ‘consumers’ who demand funds

· Lenders are ‘producers’ who supply funds
· Price of money in money market is determined through rate of interest
· Workings of the money market have effects on every other part of the economy

Individuals
· Borrow mostly for personal reasons
· Most common form of borrowing is mortgage arrangement
· Bank has home as the security of the loan in case of default payments in which the bank
has the ability to sell the house to repay the debt
· Also borrow for shorter term purposes such as purchasing a car and travel
· Credit cards are loans that are mostly unsecure and therefore there is no financial assets
financial institutions can claim if borrowers default and as a result interest rates are usually
higher compared to mortgage rates

Business
· Does most borrowing of any sector in the economy
· Need funds to expand production, invest in Research and Development and complete other
special projects
· Funds can be accessed through raising equity by issuing shares or raising debt by issuing
bonds
· Also need to borrow money to overcome downturns of cash flow in the business eg.
Tourism companies

Government
· Sometimes deliberately borrow to increase level of economic activity
· Slow growth rate means the government may borrow money to increase spending or give
tax cuts to stimulate economy
· May also borrow if spending unintentionally grows quicker than revenue
· Governments also borrow to fund major infrastructure projects with the intention of the
money being paid off during the lifetime of its use
 Factors Affecting the Demand for Funds
· Individuals with surplus funds must decide whether to keep in money form (currency and
bank deposits) or financial assets (bonds and shares)
· Benefit of holding money is liquidity (the ease in which a financial asset can be transformed
into cash so it can be used as a medium of exchange)
· Other benefits of having money is:
Transactions Motive – money needed to complete necessary day-to-day transactions such
as purchasing of goods and services
Precautionary Motive – unpredictable circumstances and emergencies eg. Sickness
Speculative Motive – financial assets carry risk of capital gains and losses. If losses are
expected the assets will be converted into money
· Demand for liquid funds depends on sophistication of the financial system
· In very simple financial systems individuals will want to carry more cash
· Enhanced operation of financial markets has made it easier to convert financial assets into
liquid funds
· Main opportunity cost of holding funds is the foregone returns that would’ve ben earned by
holding financial assets
· As long as the benefit of holding liquidity outweighs the costs, individuals will seek to hold
money rather than financial assets
· Financial innovation can affect consumers’ demand for liquidity and also reshape financial
markets eg. Increased use of technology to deliver financial services
· Demand for funds by business are determined by a variety of factors which include cash
flow generated by business operations, whether cash flow is sufficient to cover expenses
and general economic conditions

Lenders
· Individuals who place deposits in financial institutions are lending their money with the
intention of getting a return on it
· Some individuals may invest in assets or purchase shares
· Business may deposit funds in financial institution instead of expanding of business if
interest rates are more lucrative than investing in business expansion
· When governments have a surplus they either repay outstanding debts or maintain positive
financial balances (loan money through financial sector)
· Australia has historically low savings rate and has relied on overseas savings to finance
domestic consumption and investment
· Australia net foreign debt over $1 trillion by 2017
· Banks and other lenders in Australia were forced to raise interest rates in excess of official
increases in cash by the reserve bank to attract overseas funds to lend to borrowers in
Australia.

Monetary Policy

Monetary Policy: is a MACRO economic policy that aims to influence the cost and supply of
money in the economy in order to influence economic outcomes such as economic growth
and inflation

The RBA administer monetary policy by influencing the level of interest rates

Objectives:
· Stability of the currency
· Full employment = 5%
· Economic prosperity and welfare of the people of Australia
Inflation Target:
· Keep inflation at 2-3 percent, on average over the medium term

Reserve Bank Board:

· Governor, deputy governor, treasury secretary and six external members
· Monthly meeting includes decision about setting the cash rate

Reserve Bank --> Official cash rate --> Banks --> Interest Rate

Official Cash Rate: The interest rate on unsecured overnight loans between authorised
deposit-taking institutions, most important of which are the BANKS

Borrowing vs Lending
· You borrow money at 2.5% (BORROWING RATE)
· Bank lends out your money at 3% (LENDING RATE)
· Makes a profit
· Difference between the two is called INTEREST RATE DIFFERENTIAL

Role of reserve bank in determining the cash rate

· The stance of monetary policy is expressed in terms of a target for the ‘cash rate’
· On the first Tuesday of each month (except January), the board of the RBA meets to
determine the appropriate stance of monetary policy in Australia. At 2:30pm, just after the
conclusion of the meeting, the governor issues a press release announcing the board’s
decision, along with an explanation for decision taken

Exchange Settlements Account (ES)

· Banks have deposit accounts with the RBA called ‘Exchange Settlements Account’. These
are the accounts across which the myriad of transactions in the economy are settled each
day.
· Exchange settlement account à Cash rate is the cost of money in this account à Supply and
demand of funds within this account affects the cash rate à Reserve bank alters the supply
and demand in order to change the cash rate
· The RBA keeps the cash rate at target by setting the supply of funds in exchange settlement
accounts so that it is consistent with demand

Domestic Market Operation

· Is the process by which the bank indirectly impacts the interest rate by manipulating the
demand and supply for overnight funds in the short-term money market
 Reducing the Cash Rate
• To achieve an expansionary monetary stance: the RBA purchases government
securities from the banks and other financial institutions in the cash market. This
leads to an increase in the supply of funds in the market when the RBA transfers
payments to the exchange settlement accounts of the banks.
• The increase in the supply of funds puts downward pressure on both the cash rate
and the market rates of interest.
• E.G. a ‘loosening of monetary policy’ occurred between 2011 and 2013 when cash
rate declined from 4.75% to 1.75%. (May 2016) This was aimed at increasing
economic growth and employment in the ‘transition phase’ of the Australian
economy.

Increasing the Cash Rate

• To achieve a contractionary stance: the RBA will sell new government securities.
The banks need to withdraw funds from their exchange settlement accounts to pay
for these securities. Then individual banks have to borrow funds to maintain their
exchange settlement account balances as required by the RBA.
• A reduction in the supply of cash in the money market raises the cost of borrowing
and puts upward pressure on interest rates.
• E.G ‘tightening on monetary policy’ between 2009 and 2011 when the cash rate
increased from 3% to 4.7.5% . This was designed to reduce the inflationary pressure
coming from the mining investment boom

The Transmission Mechanism

· Explains how changes in interest rates are transmitted through the financial system and the
economy, and the impact on areas such as inflation and unemployment.
· Decision to increase target cash rate means that inflation may decrease in 6-18 months
· Decision to decrease target cash rate means that inflation may increase in 6-18 months