Policy Impact

Low Inflation

Although government expenditure represents in excess of 20% of aggregate demand, the impact is such that it is unlikely that this spending will add undue pressure to aggregate demand. However, this was not always the case.

When using the Keynesian approach, government actions impacted the level of inflation experienced in two ways Australia. The first was due to the increase in pressure on aggregate demand. In theory, we know that when aggregate demand increases, the economy may experience some upward pressure on prices.

After the Rudd government was elected, the goals of budgetary policy were altered. In particular, the government began using the budget to have a far more direct impact on the domestic goals of the Australian economy. The new Prime Minister believed that the previous government had missed an important opportunity; in spending the large amount of money that was generated through the automatic stabilisers during a strong economic period, it was argued that the Howard/Costello government had actually added to inflationary pressures in the economy. Mr Rudd and his treasurer (Wayne Swan) set about trying to rectify this problem.

One of their first goals in relation to fiscal policy was to try and increase the size of the surplus from 1% of GDP to 1.5% of GDP. The goal in this instance was clear - it was believed that the economy did not need any further stimulus from the federal government, and so there was no point in spending more than was required. It was hoped that this would have directly the opposite impact of that illustrated in the graph above; aggregate demand would be restrained, and therefore the government would not be contributing to pressure on domestic productive capacity. The end result is that inflation should be lower.

As we now know, these events did not come to pass. It is worth remembering, however, that through these early statements the Rudd government signalled a change of intention. As a result of their switch back to a Keynesian philosophy in regards to budgetary policy, the government declared that they had a role to play in ensuring that inflation remained within the goal range.

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