Policy Impact

Sustainable Economic Growth

In theory, there are two main ways in which fiscal policy can be used to improve economic growth in Australia. The government can either add to growth directly by running a budget deficit, or they can try to minimise their impact in the market and encourage private sector investment. After 1996, the Howard government elected to follow the second option. Therefore, any impact on economic growth in Australia as a result of changes in the fiscal stance is indirect.

Prior to 1996, the impact is relatively easy to imagine. From the circular flow diagram of Economics, we can see that all the government needed to do was ensure that the injection made as a result of government spending was larger than the leakage caused by taxes. This would lead to higher levels of production, and therefore economic growth. Obviously if spending exceeds revenue, this equates to a budget deficit. This was the approach advocated by John Maynard Keynes in the 1920s and 30s, and as such it is often referred to as a traditional Keynesian approach.

Today, the picture is slightly more complicated. Fiscal policy is no longer directly used to target economic growth, and as such large budget deficits are unlikely to occur. Instead, through the process of fiscal consolidation the federal government hopes to ensure that long term growth is sustainable. There are three main flow on effects of the federal budget that should help to ensure that this is the case. Firstly, with no net call on national savings, the government does not put undue pressure on the money supply. This allows for interest rates to remain relatively low. And secondly, the government aims to maximize private sector investment by minimising the size of the government contribution to the Australian economy. When investors know that they will not be forced to compete with the government sector, they are more likely to begin new businesses. Finally, the government can also use fiscal spending to enhance Australia's infrastructure. When the government provides a good road network, or acts to improve the efficiency of the ports, the productive capacity of the economy is improved. This should also add to our economic growth.

Both approaches can work. The significance of fiscal consolidation is that the federal government believes this process will lead to the same results with no negative consequences for Australia’s external stability. During the final years of the Keating government, the large budget deficits contributed to a very poor performance in regards to the balance on current account. Despite this, growth at this time was positive.

In the final years of the Howard government, the opposition was critical of the fact that the government did not use the large surplus that was generated each year to try and enhance our infrastructure. As a result, the economy experienced slightly lower rates of growth than might otherwise have been the case. It is also true to say that pressure on productive capacity increased, and this resulted in higher levels of inflation. In other words, the growth which we did see was not sustainable, and therefore the RBA needed to respond by increasing interest rates. This is particularly evident in 2006 and 2007.

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