Determining the fiscal policy time-frame: the dominance of exogenous circumstances.

Abstract

Fiscal policy is one of the fundamental tools of political management, and of macro-economic policy. This paper largely confines itself to the second of these functions. It investigates the question of whether there are any circumstances which justify using fiscal policy in a counter-cyclical stabilisation role. The economic issues relevant to this question are assessed, on the basis of the literature and empirical evidence, under three headings: 1. the objectives to which policy may effectively be directed; 2. the economic circumstances and outlook; and 3. the varying impacts and lags of the principal policy instruments. This analysis recognises the close inter-relationships between fiscal policy and the other principal macro-economic policy instruments (monetary policy and wages policy). The evidence suggests that there is a countercyclical role for fiscal policy in circumstances where there is a significant Keynesian slump in aggregate demand. Such circumstances demand active fiscal response, that is, allowing the automatic stabilisers to perform their "duty" will not be a sufficient enough injection to effective demand to arrest the slump.

In periods of growth, and/or in the presence of a high current account deficit that is indicative of structural imbalance within the domestic economy, however, there are strong grounds for assigning wages policy to the employment (and growth) objective/s. This allows policy-makers the choice of switching fiscal policy to the structural issues such as the balance of payments: a particularly important option for Australia with its relatively high vulnerability to exogenous economic shocks.