Activity 8(d)

Activity 8d: The importance of Budget forecasts


  • a. Employment growth of 3.3% is relatively strong the budget estimate of 2.75%. It indicates that the number of people in employment grew more than the government expected over the relevant year. It positively impacts on incomes earned in the economy, which in turn adds to tax revenue (and reduces government expenditure on welfare to the extent that unemployment is likely to fall), which reduces the deficit.
  • b. An unemployment rate of 3.5% as at the 30th of June 2022 was 0.5 point lower than the 4% anticipated by the government. As for part a, this should reduce government expenditure, as fewer people will be relying on government income support, as well as raise government revenue to the extent that the lower unemployment rate is consistent with growth in incomes. overall, it exerts further downward pressure on the budget deficit.
  • c. Growth in the CPI of 6.1% for 2021-22 is higher than the 4.25% expected by the government. Ordinarily, a higher than expected rate of inflation will initially have a favourable impact on the budget outcome as higher inflation not only contributes to bracket creep (as people move into higher tax brackets), but the higher inflation typically goes hand in hand with growth in economic activity – i.e. demand inflation pressures are present.  In this context, a higher than expected rate of growth in inflation should help to reduce the budget deficit as government revenues increase and government expenditure falls. However, If inflation is caused primarily by cost pressures in the economy (i.e. cost inflation), as was the case in 2022, then it can actually increase pressure on the deficit (despite the existence of bracket creep) because is contributes to a slow down in the economy and an automatic decrease in revenue and increase in expenditure.
  • d. Growth in nominal GDP of 12.1% exceeds the expected rate of growth in nominal GDP of 10.75% for 2021-22. This occurred primarily because of the higher expected growth in the terms of trade/commodity prices, which in turn increased government revenues (above the levels expected) as mining companies generated more income from their activities. [It also helped to reduce government expenditure to the extent that growth in the mining sector helped to reduce unemployment.]
  1. In light of the improved economic conditions relative to what was expected at budget time, and the favourable impact this had on the budget outcome (reducing it from an expected $79.8 billion to an actual $32 billion), the government can respond by spending more, and/or taxing less in the following year’s budget on account of the general improvement in revenue/expenditures. Alternatively, it can decide to leave the following budget untouched (not change the structure of the budget) and allow the more favourable budget parameters to flow on and reduce the size of government debt.  [In reality, the government decided to be a little more generous than otherwise in the 2022-23 Budget].
  1. Nominal GDP increased by more than real GDP over this period because the increase in the value of production (by 12.1%) largely occurred because of growth in ‘prices’ of commodities. Given that real GDP extracts the effects of price movements, it resulted in the growth in nominal GDP being deflated to 3.6%.  [The 8.5 percentage point difference between the two is accounted for primarily by the higher prices received for Commodities like natural gas, iron ore, coal, lithium, etc.]
  1. This is because the huge growth in commodity prices (and by extension the terms of trade) experienced in Australia over of the past few years is expected to be reversed. This necessarily means that the growth in nominal GDP will be much lower than before and once the (negative) price effect is removed, real GDP growth will be higher.
  1. Given that the wage price index is a measure of the average wages received by workers, then it means that real wages growth will be negative when growth in the CPI is greater than growth in the WPI. Accordingly, it indicates that the purchasing power for wage earners on average declines which has a negative impact on material living standards.
  1. These changed forecasts, on the face of it, indicate that the economy will be stronger than previously expected which exerts downward pressure on the budget deficit for 2022-23. Stronger growth in nominal GDP suggests that commodity prices are rising faster than forecast (or falling slower than forecast), having a favourable impact on mining company revenue which then translates into additional company tax revenue for the government.  In addition, the growth in the wage price index translates into higher income tax revenue for the government, both of which raise revenue relative to expenditure and reducing the size of the budget deficit. These are indicative of cyclical changes to the budget given that they have occurred purely as a result of changes in the level of economic activity rather than any deliberate attempt to by the government to make changes to the structural component of its budget (e.g. changing tax rates).