Policy Impact

Price Stability

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.

With large budget deficits prior to the 1996 election, the Keating government was structuring the budget in such a way that government spending was adding to demand side pressures in this way. Partly as a result of these actions, despite increasing interest rates during this period, inflation peaked at 4.2% in 1995/6.

However, there is a second impact on price stability. The Keating government initiated a process of microeconomic reform that resulted in the selling of many government run businesses. During the early 1990’s the sale of the Commonwealth Bank and QANTAS were both started. This process was implemented through the federal budget. These businesses, once privatised, became far more efficient. As a result, the upward pressure on prices that had existed in the 1980’s was gone – prices became far more stable. For example, the cost of a local telephone call has fallen dramatically in real terms since Telstra was partly privatised in 1996. (This will be examined in more detail when you are studying the microeconomic reform process.)

Today, the impact on price stability should be considered in a slightly different way. After the election of the Rudd government in 2007, the Prime Minister was very keen to achieve two fiscal goals very quickly. First, he wanted to increase the size of the budget surplus. In this way, he was recognising that although the Keynesian philosophy was no longer being followed, it didn't prevent the Keynesian impact from being felt. A larger surplus should help to remove some of the pressure on productive capacity. And secondly, he was also very keen to increase investment in Australia's infrastructure. For example, plans to create a system that would allow national access to a very fast broadband internet connection were put in place very early. In this way, he was signalling his government's intention to increase our productive capacity. Combined, these decision should help to result in a lower rate of inflation in Australia.

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