Fiscal policy is a macroeconomic instrument that involves the manipulation of the Commonwealth s revenue and expenditure, in managing the

level of aggregate demand in the economy. It is effective in addressing demand or cyclical issues in the short-to-medium term and does not have a direct impact on structural or supply issues. Fiscal policy is able to assist in achieving Australia s economic objectives of sustainable economic growth, low unemployment, low inflation, strong external stability, fair distribution of income and environmental sustainability. The implementation of fiscal policy has been a medium term framework tool used by the Australian government to provide stabilisation and sustainability of the business cycle via its counter cyclical policies. However it should be noted that it could be used as a macroeconomic policy to influence aggregate demand or to implement microeconomic reforms (targeted reforms to specific industries or sectors in the economy, such as tax reform or changes to the compulsory superannuation). The government exercises fiscal policy to keep economic growth at a sustainable level (with a preference of 2-4%) i.e. to avoid high inflation and a current account blowout. Fiscal policy can effectively alter consumer and business spending through the alteration of expenditure and/or taxes, which has a direct effect on economic growth. It can prove to be inflationary as noted in the 2007 budget, which was a major factor as to why the Reserve Bank of Australia (RBA) increased rates. It can target particular sections of the economy, which allows it to raise or lower growth with regards to inflationary sectors of the economy. It has been regarded as effective as it successfully fostered an extended economic cycle, despite the contractionary forces from the global economy. Over the past decade the budget has moved from a deficit of $4.2 billion in 1997-98 to a surplus of $23.3 billion in the 2008-09 financial year. However, with the outbreak of the global economic crises the Rudd government was forced to run a huge budget deficit of approximately responding to slow economic growth of 0.4%. The government employs the strategy of fiscal consolidation which will through the crowding in effect encourage business confidence and complemented by expansionary monetary policy of lower interest rates increase private sector investment expenditure. This will boost aggregate demand, output and employment, which will generate higher levels of national saving and reduced reliance in foreign borrowing to finance investment expenditure. Fiscal policy with a demand management role can react to short-term fluctuations in the domestic economy to restore or sustain economic growth.

In the last decade the use of fiscal policy to influence income distribution has been effective. The government can achieve a more equal distribution of income through progressive taxation. This allows the reallocation of funds from the wealthy in the form of altering marginal rates and brackets and providing it to the lower quintiles in the form of welfare payments. In 2004, before government intervention, the lowest 20% of the population were earning 0.8% of total income whereas the highest 20% were earning 47.6% of total income. As a result of taxation, the share of final income received by the lowest quintile was increased to 14%. The idea of increasing social welfare was first introduced during the Whitlam government when unemployment benefits more than doubled in real terms and criteria s for the disability pension expanded. The policy initiatives reflected in strong growth in as GDP had increased by 6 percentage points but it represented 6.25% of GDP. Since then social security and welfare expenditure has increased to 10.5% of GDP. However, the implementation of the regressive goods and services tax in 2000 along with reduced tax rates for higher income earners has led to greater income inequality. The lowering of unemployment rate to around 5% for several years has lowered the inequity of distribution of income. Since the emergence of the Global Financial Crisis (GFC), governments around the world including Australia have responded to the instability in the financial markets by conducting expansionary macroeconomic policies, both fiscal and monetary, in the form of discretionary stimulus packages to support aggregate demand. Within a month of Lehman Brother s collapse, the Reserve Bank of Australia decreased interest rates by 100 basis points, the first discretionary fiscal stimulus package (Economic Security Strategy) was announced and the government declared guarantees for bank deposits and term funding. 1 In order to combat the issues of rising unemployment and falling economic growth, the Australian government has produced an expansionary fiscal stimulus package over $42 billion. Most of the early spending was on cash transfers provided to low-middle income earners with dependant children. This group was targeted, as they were most likely to have a higher marginal propensity to consume. The remainder of the spending was allocated to a range of investments aimed at providing a longer-term direct contribution to aggregate demand and the economy s supply potential.In order to maintain growth within the construction industry, the Rudd Government increased the First Home Owners Grant to
1

Gruen, D,2009, The return of Fiscal Policy

$21000, which would increase employment within one of the worst hit industries (construction). The Rudd Government has used the stimulus package as an attempt to address environmental issues. The solar energy rebates will reduce consumption of electricity but would also promote employment in an emerging environmentally friendly industry. Retail trade had increased by 4% in the December quarter and remained strong supported by the cash payments. By October 2009, retail trade was 5.4% higher that pre-stimulus level in November. It had become clear that Australia had avoided a recession and consumer and business confidence rebounded sharply and kept rising. Fiscal multipliers of 0.6 for cash payments and 0.85 for government investment spending induced a rise in output thus stimulating consumption and resulting to a larger overall fiscal stimulus.

Whilst recognition lags and lack of a clear trigger played a major role in the 1990 s recession, it did not account for the delay in implementing discretionary fiscal stimulus. The collapse of Lehman Brothers and American Insurance Group in mid September 2008 it provided the signal that a severe contractionary force was to envelope the world. The signal combined with the rapid response to rapid discretionary fiscal stimulus and rapid monetary policy provided support to the domestic economy over the subsequent months and quarters. It is clear that the Australian government had learned from its mistake. Stevens states, If both monetary and fiscal policy had not acted as swiftly and substantially then Australia would experience a severe protracted downturn with a more malign outcome 1. BIBLIOGRAPHY Henry, Dr K. 2010, Fiscal Policy and the Current Environment Henry, Dr K. 2009, Fiscal Policy: More than just a budget Gruen, D, 2009, The return of Fiscal Policy

Henry, Dr K. 2010, Fiscal Policy and the Current Environment