Activity 8(e)

Activity 8e: The changing role of Budgetary policy

  1. This refers to the role that the budget plays in helping to restrain the rate of economic growth (and inflation) during times of rapid economic expansion (e.g. a boom in the business cycle) and to stimulate the rate of growth during times of rapid economic decline (a trough in the business cycle).


  1. Prior to 2007, governments used budgetary policy to facilitate the delivery of budget/government measures that were ultimately designed to improve the economic prosperity and welfare of Australians. There was less a focus on using the budget to assist monetary policy in stabilising economic activity and more focus on the need to collect tax revenue in the most efficient way and using this revenue on government expenditure or programs that are designed to achieve The most efficient allocation of resources and boost living standards.


  1. The role of budgetary policy changed because of the (global) economic downturn experienced as a consequence of the global financial crisis of 2008. The government at the time felt that monetary policy in isolation was insufficient to deal with the economic pain caused by the crisis.


  1. A technical recession is defined as two consecutive quarters of negative economic growth. The budget helped Australia to avoid a technical recession because the Government introduced revenue and expenditure measures (both cyclical and structural changes) that resulted in a more expansionary budgetary policy stance.  This combined with the more expansionary monetary policy at the time to ensure that the rate of decline in economic activity did not persist for more than a few months.


  1. The strategy at the time (to achieve budget surplus on average over the cycle) acknowledges the impact of the economic cycle on budget outcomes – with the outcome deteriorating during periods of economic decline and improving during periods of economic expansion. This means that the cyclical component of the budget is allowed to operate in a way that supports the economy during a downturn and restrains the economy during a boom.  However, it also provides the government with a ‘licence’ to introduce further structural changes to the budget during a downturn which both raise the budget deficit (or reduce a surplus) and provide stimulus to the economy.  The reverse applies during a boom such that, overall, the previous budget strategy allowed for the budget to be used in a countercyclical way that manifested in higher deficits during downturns, and higher surpluses during booms such that over time, the balance on average was a small surplus. [Note the strategy changed in the second of the 2022-3 Budget – see Section 8.12 of text.]


  1. Internal stability also refers to the achievement of domestic economic stability which involves the simultaneous achievement of strong and sustainable economic growth, full employment and price stability. There are several ways that the government can use the budget to achieve internal stability.  For example, as described above, the government could deliver structural changes to the budget (such as lower tax rates) during a recession in order to stimulate economic growth and jobs (and potentially help inflation to rise into the RBA’s target range of 2-3%).


  1. The budget has a major role in redistributing incomes in the economy and it does this primarily via the tax and transfer system. The progressive nature of Australia’s income tax system, combined with the provision of income/welfare support programs, effectively redistributes incomes from higher to lower income earners.