Global fiscal stimulus combined with accommodative monetary policy can have significant multiplier effects on the world economy. The International Monetary Fund has called for fiscal stimulus in as many countries as possible as it works to stimulate spending and economic activity directly, effectively bypassing the financial sector in its first-round effects (Freedman, 2009). Each type of fiscal policy will have a varying impact on economic activity and fiscal balances, whether it is in the form of tax cuts, industry specific support, direct investment, cash handouts or more recently, credit guaranteeing.
Fiscal Stimulus in Australia
Using recent national accounts data, this question examines whether the extensive fiscal stimulus program implemented by the Australian government in 2008-09 countered the GFC-induced economic slowdown, as measured by variation in real GDP, especially during the critical December 2008 and March 2009 quarters. With reference to the expenditure measure of GDP, it reveals that a marked rise in net exports at this time, not fiscal stimulus, was primarily responsible for offsetting the fall in domestic private investment due to the GFC. Next, the paper contends that the Australian economy most likely experienced a relatively mild recession in 2008-09 by past standards when assessed with reference to a broader set of national income and employment indicators, as is standard practice for determining and dating recessions in the United States. To counter a predicted recession in the wake of the global financial crisis (GFC), In Australia, the first fiscal stimulus package (October 2008 - the Economic Security Strategy) mainly consisted of cash handouts to pensioners and families. There was an extension to the First Home Owner Grant Boost and some training places offered. However, the second package (the Nation Building Package) focused on infrastructure development. This was followed in February 2009, as the recession looked like deepening with the $A41.5 billion (that is, economically significant with respect to GDP) allocated to the Nation Building and Jobs Plan. This fiscal response aimed to stimulate aggregate demand through increased consumption and investment expenditure, and has been credited with saving Australia from recession (Australian Treasury Budget Papers 2010), based on a definition of recession as two consecutive quarters of declining real GDP.
Using AS/AD model to show the effects on Fiscal Stimulus
For e.g. The following fiscal policies defined here are discretionary, meaning they are at the option of the government, often the Council of Economic Advisers (CEA).
Expansionary fiscal policy: helps an economy out of recession and to reduce unemployment
Increase government spending (the most direct method)
before the government spending increase : GDP↓, PL ↓
after the increase in government spending : G ↑ → AD ↑ → GDP ↑, PL ↑, UE ↓
Tax reduction
before the tax reduction : GDP↓, PL ↓
after the tax reduction : T ↓ → DI ↑→ C↑→ AD ↑ → GDP ↑, PL ↑, UE ↓
Combination of both to achieve greater effects, but by themselves, government spending leads to a higher level of GDP.
Will a stimulation of Aggregate Demand Cause Growth or Inflation?
Like the microeconomic supply-and-demand model, changes in equilibrium in the AS/AD model are caused by changes in the variables that affect supply and demand. The relationship between AS, AD and price are represented by the slope of the AS and AD curves; changes in all other variables cause the curves to shift right or left. A review of the list shows some overlap or redundancy. For example, both interest rates and credit availability are related of course, and one might be used to the exclusion of the other. Despite the fact that these are related, there is a difference between them. For example, credit extended by credit cards became more readily available to consumers in the late 1970s and throughout the 1980s because computerization lowered transaction costs. This is an institutional reason for credit availability and would be reflected in a model concerned with showing the effects of this institutional change.
As stated above, historical inflation rates are not perfectly consistent over the phases of different cycles. Inflation, nonetheless, is intricately related to the dynamics of the cycle. Because aggregate demand is relatively volatile compared to aggregate supply and is so easily stimulated by policy, the question posed above is strongly related to business cycle dynamics. An inspection of the list of factors that can effect aggregate demand expose many candidates for a stimulation to aggregate demand. In the area of policy, for example, either an increase in government spending or a decrease in taxes can shift the AD curve right. Expansionary monetary policy, increasing credit availability and reducing interest rates, So can a growth in consumer confidence, represented by an increase in income expectations. In any of these cases, the AD curve would shift sharply right. For the sake of discussion, assume the stimulation came from expansionary monetary policy. With such a stimulus, interest rates would drop and both credit and money supply growth rates would surge. Aggregate demand would respond by shifting right. Complicated economic relationships are seldom well represented by simple ideas or slogans, however the above shows why this is true when considering the relationship between expansionary monetary policy (and high credit and money supply growth rates) and inflation. If a strong stimulus to aggregate demand, such as an expansionary monetary policy, is applied near the trough of a recession, as is shown in above figure, there is plenty of room for non-inflationary real growth with very little inflation. If the starting point, in other words, is well back on the non inflationary range of the AS curve, inflation is not likely to be a problem. In the real economy this might imply that the capacity utilization rate, at the starting point of the stimulus, is unusually low - perhaps below 70%. Likewise the unemployment rate is likely to be high and resources available. There would not be many bottlenecks, labor shortages or severe cost constraints in the economy. With their excess capacity, manufacturers could satisfy the resulting surge in sales by utilizing existing capacity. Inflationary pressures would not emerge. The initial inflation caused by the monetary stimulus is shown as the movement in the AD curve from AD to AD2. It results in an increase in the inflation rate from P1 to P2. As inflationary expectations begin to be formed from this experience, however, a secondary, additional stimulus effects aggregate demand, moving the AD curve out to AD3. This continued surge in inflation, from P2 to P3, reflects the effect of inflationary expectations. Such expectations, therefore, have the effect of compounding the inflation.
(b)Price-Level-Targeting
A monetary policy goal of keeping overall price levels stable, or meeting a pre-determined price level target. The price level used as a barometer is the Consumer Price Index (CPI), or some similarly broad measure of cost inputs. A central bank or monetary authority operating under a price level targeting system raises or lowers interest rates in order to keep the index level consistent from year to year.
Monetary policy
The Reserve Bank of Australia is responsible for formulating and implementing monetary policy. For countries like Australia with floating exchange rates, monetary policy involves the management of short-term interest rates to achieve domestic policy objectives. Countries following this approach include Australia, the United States, Japan and New Zealand - in fact, most of the OECD countries. In some countries, an alternative focus for monetary policy is the exchange rate: a country may choose to have their exchange rate fixed to a major international currency, or in some kind of target band. In this case, monetary policy essentially involves the management of that exchange rate commitment. A number of smaller economies have fixed exchange rates, for example, Hong Kong, whose currency is fixed to the US dollar.
Measures to improve price level
The RBA has had an inflation target to ensure that price stability is maintained and increases in the general price level are kept to a minimum. Under the policy of inflation targeting, the RBA is aiming to keep the inflation rate, as measured by the CPI, to an average of 2 to 3% per annum in the medium-term. The Consumer Price Index (CPI) is an important economic indicator. It provides a general measure of changes in prices of consumer goods and services acquired by Australian households. The CPI is used for a variety of purposes, such as in the development and analysis of economic policy, the adjustment of wages and pensions, and in individual contracts. Because of this, the CPI directly or indirectly affects all Australians. The objective of the CPI is to measure price changes for a comparable basket of goods and services over time, some allowance must be made for changes in the quality of a product (e.g. computers) when calculating price movements. This notion of pricing to constant quality is achieved by estimating and then removing the contribution of the quality change to price movements. An argument against the use of quality adjustment to pricing is that it does not represent the shelf price of goods and services.
(c) (1) The amount by which a government's, companyHYPERLINK "http://www.investorwords.com/992/company.html"'HYPERLINK "http://www.investorwords.com/992/company.html"s, or individual's income exceeds its spending over a particular period of time. Generally, a government does not need to maintain a budget surplus. However, a government has to be careful about running a budget deficit to make sure that the means of financing the deficit do not cause too much of an interest burden. In general, economists become worried when government debt, the most common way of financing a government deficit, rises sharply as a proportion of Gross Domestic Product. This is because interest payments might also rise as a proportion of Gross Domestic Product unless the government manages to sufficiently reduce the average interest rate paid on the debt. An increasing interest burden means that government revenues will be diverted to pay for financing HYPERLINK "http://www.businessdictionary.com/definition/financing-cost.html"costs, as opposed to being used for more productive purposes. As in the case of the government, individuals and corporations do not have to ensure that their budgets are in surplus or balanced, but they have to be mindful of interest costs as a proportion of their income. Some economists believe that manipulation of the government budget surplus is an effective way of stimulating or slowing economic growth. However, other economists say that manipulating the budget deficit will only result in a change in the price level in the economy, since actual production change in an economy is only decided by changes in the labor force, the state of technology, and productivity of the workforce.
Budget surplus in 2013 (Australia)
A plan to return the budget to surplus is a key element of fiscal sustainability. Fiscal sustainability is the capacity of the Government to efficiently finance present and future expenditure programs. Efficient financing requires choosing financing methods that support economic growth and living standards.
Fiscal sustainability is essential for maintaining macroeconomic stability, reducing economic vulnerabilities and improving economic performance. It reduces the degree of uncertainty about future fiscal policy settings and facilitates decision-making within the economy, especially regarding the accumulation of physical and human capital, technological progress, workforce participation and productivity.
The Government has a clear, achievable strategy to return the budget to surplus. The Government will allow the level of tax receipts to recover naturally as the economy strengthens and will hold real growth in spending to 2 per cent per annum, once economic growth is above trend, until the budget returns to surplus.
The alternative approach
Following a major fiscal policy review, I suggest that it will legislate a fiscal rule in respect to the budget balance. This represents a significant development in a much-admired fiscal policy framework which was introduced more than a decade ago, during a period of major fiscal consolidation. Central to the Swedish framework as it has operated to date has been a system of fixed medium-term aggregate expenditure ceilings. These ceilings have been informally linked to a target of a 1 percent budget surplus over the business cycle. What the new approach will do is to transform that budget balance target into a binding fiscal rule. This is seen as a central part of the Swedish commitment to a sustainable fiscal "exit strategy" from the global crisis. Under the Swedish framework, aggregate expenditure limits are set three years in advance and are then strictly binding. The great advantage of such aggregate expenditure ceilings is that they can restrain pro-cyclical expenditure patterns, by counteracting the tendency of governments to increase expenditure unsustainably during boom periods on the back of temporary revenue surges. Such pro-cyclical expenditure surges are a key source of fiscal sustainability problems. The aggregate expenditure ceilings have therefore been the feature of the Swedish model which has attracted the greatest degree of favorable international attention. Under the approach which has operated in Sweden to date, the 1 percent budget surplus target has been applied ex ante, but has not been binding ex post. In other words, when the medium-term aggregate expenditure ceilings are set, they are supposed to be consistent with the 1 percent over-the-cycle budget surplus target. However, if during the period of currency of the ceilings, it transpires that the surplus target will be breached, the expenditure ceilings are not revised downwards. Medium-term aggregate expenditure ceilings should not be confused with the notion of fixed ministry ceilings. Sweden does not translate the aggregate ceilings into multi-year commitments to spending ministries. Indeed, the move to turn the deficit target into a strict rule would make it most unwise to make such commitments, for reasons which I outlined in a previous blog piece - namely, that this would then require that any fiscal tightening required by the deficit rule take the form exclusively or mainly of tax increases rather than spending cuts. With the introduction of a firm budget balance rule, it will be essential that the aggregate expenditure ceilings are treated only as ceilings and not as floors. Transforming the budget balance target into a fiscal rule will also make it essential to specify precisely how the budget balance is defined for the purpose of the rule. A clear definition is currently lacking. The Swedish Fiscal Policy Council - an independent body established by the government in 2007 - has criticized the vagueness of the deficit target to date, noting that the government has used five different definitions of the budget balance with reference to the 1 percent target. Clarification will also be required as to the way in which the deficit is defined in respect to the business cycle. It may be necessary to change from the current formulation of the 1 percent surplus requirement in terms of "over the business cycle" - respect for which can only be judged after the event - to definition in terms of a structural budget balance measure, calculated annually. Broader debate is underway in Sweden on other aspects of its fiscal framework. One of these is the comprehensiveness of the aggregate expenditure ceilings. The Swedish expenditure ceilings have to date covered virtually all government expenditure - including cyclically-sensitive expenditure such as unemployment benefits. This largely blocks the operation of "automatic stabilizers" on the expenditure side. In other words, it prevents those automatic increases in expenditure such as unemployment benefits during a recession which help to stabilize the economy. In its comments on the 2009 budget, the Fiscal Policy Council criticized this approach, suggesting that "the expenditure ceiling should not block central government expenditure if there are compelling cyclical reasons for allowing it to increase. It would be desirable to get a crossparty agreement on the possibility of exceeding the ceiling in exceptional circumstances." Absolutely - but a simpler approach would surely be to exclude such expenditure from the aggregate ceilings, as happens in most other countries which set fixed medium-term aggregate expenditure ceilings. Note that the existence of a so-called "budget margin" gives a little scope to cut aggregate expenditure under these circumstances.
In an article Wayne Swan delivers an approach to make budget surplus
THE unexpected strength of the labour market opens the prospect for the Federal Government bringing the budget back to surplus earlier than forecast, an economist at one of the nation's major banks says. Treasurer Wayne Swan and Finance Minister Lindsay Tanner have already dismissed research by one investment bank that suggests the budget could be back in surplus in 2012 rather than 2013. Mr Swan has said that sort of speculation is "pie in the sky". Westpac senior economist Anthony Thompson, in releasing a new business survey on Thursday, was asked whether the federal budget could be brought back to surplus early. "That is a prospect," he told reporters in Canberra, adding that faster than expected labour market improvement was a factor. The unexpected drop in the jobless rate reduced unemployment benefit payouts and lessened the need for employment supporting programs, he said. "To that extent, it has to be a net positive." The Australian Chamber of Commerce and Industry says the government should continue with its stimulus measures in the short term. "We don't think it would be a good idea to terminate the stimulus," director of economics and industry policy Greg Evans told reporters in Canberra. In the medium to longer term the government needed to get the budget back to balance, with particular emphasis on the spending side, he said. "There should be a root-and-branch review of spending as well to get the budget back to balance."
(c) (2) A balanced budget is when there is neither a budget deficit or a budget surplus - when revenues equal expenditure ("the accounts balance") - particularly by a government. More generally, it refers to when there is no deficit, but possibly a surplus. A cyclically balanced budget is a budget that is not necessarily balanced year-to-year, but is balanced over the economic cycle, running a surplus in boom years and running a deficit in lean years, with these offsetting over time.The budget balance as a proportion of GDP is assumed to be additively decomposable into two components: the structural component (discretionary fiscal policy) and the cyclical component (automatic stabilisers). The cyclical component captures movements in the budget due to the business cycle. The only components of tax revenue assumed to be affected by cyclical variations are personal income tax, corporate tax and indirect tax. On the expenditure side, only unemployment benefits are assumed to fluctuate with the economic cycle. In equation b=bc+bs b is the total budget balance as a proportion of GDP while c b and s b are the cyclical and structural components respectively. Equation can easily be represented in terms of the cyclical component. bc =b−bs
The total and structural components of the budget balance are defined as follows:
b= and bs=
Where i t is the ith category of taxes, g is government expenditure, x is the component of the budget which is assumed not to fluctuate with activity, and y is output. An asterisk indicates a component is structural or in the case of output is at potential. The cyclical component of revenues and government expenditures (expressed as the difference between actual and structural revenues and expenditures) are assumed to respond in a predictable way to the cyclical component in output (deviations in actual output from potential output) such that:
Where α and β are tax and expenditure elasticities respectively. From equations the cyclical component of the budget balance can be derived as
1-ai}-1-β} +
Equation above shows that the cyclical component of the budget balance moves in line with deviations from potential output. These deviations are weighted by the relative size of tax revenues and expenditures and reflect their respective elasticities to movements in the deviation of output from potential output.
Question 1
(a) Consumption Expenditure
Consumption is the use of goods and services by households. Consumption is distinct from consumption expenditure, which is the purchase of goods and services for use by households. Consumption differs from consumption expenditure primarily because durable goods, such as automobiles, generate expenditure mainly in the period when they are purchased, but they generate "consumption.
Consumption Expenditure in US
Consumption expenditure grew 1.6% in the second quarter; savings rate shot up to 6.4%. The US economy thrives on consumption expenditure, which accounts for over 70% of the GDP. A high savings rate implies that consumption expenditure will remain subdued and economic growth will suffer. While a healthy savings rate is usually considered good for an economy as it provides capital for investment, the US economy has structurally modified itself to a certain extent such that it can attract capital from overseas very easily and it is more dependent on imports for its goods than producing them at home. With this structural model, the more the American consumer spends and the less he saves, the GDP grows. But, is this model sustainable? Well as long as the rest of the world is willing to lend to the US to fund its consumption expenditure, it is a feasible proposition. An article shows the U.S. personal consumption and expenditures after the 2008 crisis U.S. household consumption declined sharply in late 2008, marking a departure from the trend of a steady increase in U.S. consumption as a share of income since the 1980s. Combining econometric and simulation analysis, we estimate that this departure will be sustained beyond the crisis: the U.S. household consumption rate will likely decline somewhat further from its current level, as the saving rate rises to around 6 percent of disposable personal income (from nearly 5 percent in 2009). Compared to the pre-crisis years (2003-07), this saving rate implies a decline in U.S. private-sector demand on the order of 3 percentage points of GDP.
I expect the U.S. consumption to remain at a relatively subdued level over the next several years, with the household saving rate settling at 5-7 percent of disposable personal income, somewhat above the 2009 saving rate of nearly 5 percent. Though the estimate is subject to a sizable statistical uncertainty, it is supported by several alternative estimates and simulation analysis. Compared to the pre-crisis years (2003-07), the estimated changes in saving and consumption imply a decrease in the U.S. private-sector demand of 2-3¾ percentage points of GDP-close to a half of the U.S. current account deficit at its peak. This will have substantial effects on global economic development after the current crisis.
(b) Balance of Trade
The balance of trade is the difference between the monetary value of exports and imports in an economy over a certain period of time. A positive balance of trade is known as a trade surplus and consists of exporting more than is imported; a negative balance of trade is known as a trade deficit or, informally, a trade gap.
United States Balance of Trade
The United States reported a balance of trade deficit equivalent to 42.8 Billion USD in July of 2010. The United States is the most significant nation in the world when it comes to international trade. For decades, it has led the world in imports while simultaneously remaining as one of the top three exporters of the world. Main exports are: machinery and equipment, industrial supplies, non-auto consumer goods, motor vehicles and parts, aircraft and parts, food, feed and beverages. U.S. imports non-auto consumer goods, fuels, production machinery and equipment, non-fuel industrial supplies, motor vehicles and parts, food, feed and beverages. Main trading partners are: Canada, European Union, Mexico, China and Japan.
Source: Trading economics
(c) Relationship between Economic growth and Employment
There is an inverse relation between economic growth and unemployment. A simple statistical analysis suggests that the critical rate of economic growth is 1.60% Growth above that rate tended to push the unemployment rate down, and growth below that rate was associated with an increase in the unemployment rate to 9.60%. Because labor force growth is expected to slow somewhat in coming years, the rate of economic growth needed to prevent the unemployment rate from rising might be expected to be closer for the foreseeable future. It is not a coincidence that the global economy is experiencing the most severe case of unemployment during the worst economic crisis since the Great Depression. Unemployment is highly dependent on economic activity; in fact, growth and unemployment can be thought of as two sides of the same coin: when economic activity is high, more production happens overall, and more people are needed to produce the higher amount of goods and services. And when economic activity is low, firms cut jobs and unemployment rises. In that sense, unemployment is countercyclical, meaning that it rises when economic growth is low and vice versa.
(d) Inventory Change
Inventory change is the difference between last periods's ending inventory and the current period's ending inventory.
Entrepreneurs 'reaction to Avoid Excess Inventory
Avoiding excess inventory is especially important for owners of companies with seasonal product lines, such as clothing, home accessories or holiday and gift items. These products have a short shelf life and are hard to sell once they are no longer in fashion. Entrepreneurs who sell more timeless products, such as plumbing equipment, office supplies or auto products, have more leeway because it takes longer for these items to become obsolete. No matter what your business, however, excess inventory is something to be avoided. It costs you money in extra overhead, debt service on loans to purchase the excess inventory, additional personal property tax on unsold inventory and increased insurance costs. In fact, one merchandise consultant estimates that it costs the average retailer anywhere from 20 percent to 30 percent of the original inventory investment just to maintain it. Buying excess inventory also reduces your liquidity-something to be avoided. Consider the example of an auto supply retailer who finds himself with the opportunity to buy 1,000 gallons of antifreeze at a huge discount. If he buys the antifreeze and it turns out to be a mild winter, he'll be sitting on 1,000 gallons of antifreeze. Even though he knows he can sell the antifreeze during the next cold winter, it's still taking up space in his warehouse for an entire year-space that could be devoted to more profitable products. When you find yourself with excess inventory, your natural reaction will probably be to reduce the price and sell it quickly. Although this solves the overstocking problem, it also reduces your return on investment. All your financial projections assume that you will receive the full price for your goods. If you slash your prices by 15 percent to 25 percent just to get rid of the excess inventory, you're losing money you had counted on in your business plan. Other novice entrepreneurs will react to excess inventory by being overly cautious the next time they order stock. However, this puts you at risk of having an inventory shortage and continuing a costly cycle of errors. To avoid accumulating excess inventory, establish a realistic safety margin and order only what you're sure you can sell.
Gross Domestic Product
Changes in inventories can have a significant impact on growth in quarterly GDP. A positive change in inventories can be seen as production increasing at a faster rate than consumption but the exact reasons underlying changes in inventories can be far more complex. For example, firms may run up or run down inventories in anticipation of future sales, supply constraints could affect inventories, or firms may under or over estimate sales in a particular period.
The historical relationship between inventory change and employment.
I calculate this (using GDP inventory data), the long-term regression coefficient is 57%, not bad for quarterly changes. But there's a trick: it is very, very big in downturns, but not in recoveries. That is, layoffs correlate heavily with inventory liquidation. But job creation DOES NOT correlate with inventory rebuilding. That is because most of the jobs (I presume) are created by start-ups rather than big companies who hire and fire on the basis of inventories. Structurally, a very large percentage of job losses during recessions reflect creative destruction: big companies who lay off workers in recessions downsize permanently. The jobs are not replaced at the same companies; the old jobs go away forever, and new jobs are created at the grass roots of the economy. That's why we have to look to small business for continued job growth, and why the prospects are grimmer than the market seems to believe.
Refrences:
Journal articles from Emerald
Articles from Oxford reference
http://www.abc.net.au/lateline/content/2010/s2969628.htm
http://www.obbc.com.au/financial_planning/education_centre/interest_rates___inflation_watch.
http://www.rba.gov.au/education/monetary-policy.html
http://www.ausstats.abs.gov.au/Ausstats/subscriber.nsf/0/2ADF31DC1549C3BECA25768C001942B6/$File/64680_dec%202009.pdf
http://www.budget.gov.au/
http://www.businessspectator.com.au/bs.nsf/Article/Budget-2010-Aust-to-return-to-budget-surplus-in-20-pd20100511-5CCHM?OpenDocumentHYPERLINK "http://www.businessspectator.com.au/bs.nsf/Article/Budget-2010-Aust-to-return-to-budget-surplus-in-20-pd20100511-5CCHM?OpenDocument&src=hp2"&HYPERLINK "http://www.businessspectator.com.au/bs.nsf/Article/Budget-2010-Aust-to-return-to-budget-surplus-in-20-pd20100511-5CCHM?OpenDocument&src=hp2"src=hp2
http://www.qt.com.au/story/2010/03/18/early-budget-surplus-possible-westpac/
www.bea.gov/newsreleases/national/pi/pinewsrelease.htm
http://bilbo.economicoutlook.net/blog/?p=11270
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