Statement 4: Fiscal policy in the current economic environment (Continued)
Introduction
The global financial crisis (GFC) and its repercussions have focussed attention around the world on the conduct of fiscal policy: in particular, the appropriate balance between short‑term support for the economy and medium‑to‑long term sustainability considerations.
Fiscal objectives are not ends in themselves. They matter because of their implications for employment, incomes and wellbeing. In essence, good fiscal policy entails allowing the fiscal position to vary in response to economic conditions in the near term, while ensuring fiscal settings are sustainable over the medium‑to‑long term.
By allowing the budget balance to vary with economic conditions, fiscal policy can complement monetary policy in keeping the economy on a stable growth path, with low unemployment and inflation. This will normally occur through the automatic fiscal stabilisers, although a discretionary response may also be warranted in exceptional circumstances.
Sustainability also matters. Sustainable fiscal settings preserve governments' flexibility to use fiscal policy to counter large negative shocks to the economy while keeping governments' borrowing costs low. Maintaining fiscal sustainability over time also allows more stable tax and spending policies, and ensures that future generations do not have to bear the burden of abrupt adjustments.
Although Australia's strong fiscal position means that we do not face a significant tension between these two considerations, many other advanced economies are currently struggling to find the right balance. They have experienced prolonged economic weakness (and consequent weakness in tax receipts) since the GFC, with non‑fiscal means of stimulating growth limited because policy interest rates cannot be reduced further or, for individual euro members, because they have no independent monetary policy and exchange rate. Coupled with weak or negative economic growth and high unemployment, this normally provides a strong case for stimulatory fiscal policy.
However, a lack of fiscal discipline over a long period before the crisis, combined with the ongoing fiscal effects of the crisis, have left many other advanced economies with a legacy of very high levels of government debt. These economies also face looming fiscal pressures from population ageing over coming decades. Fears about sustainability have induced many governments to undertake substantial fiscal tightening, often over very short time‑frames. This has proved to be strongly pro‑cyclical, exacerbating existing economic weakness, which has in turn hampered achievement of fiscal consolidation objectives.
The recent international experience offers three key lessons for fiscal policy. First, the fiscal position needs to be strengthened sufficiently during good times to allow fiscal policy to respond appropriately to adverse shocks without threatening sustainability. Second, it is important to recognise and manage contingent fiscal risks, such as those stemming from explicit or implicit financial sector guarantees. Third, it is important that governments outline a credible plan to restore sound public finances following large adverse shocks, while varying the pace of fiscal consolidation in response to economic circumstances. This means balancing the requirement to consolidate against the impacts of consolidation — recognising that, in some circumstances, emergency consolidation may be needed to avoid broader economic and fiscal crises. In other cases, too rapid a consolidation may be counterproductive and undermine both full employment and debt reduction goals.
Australia is much better placed to achieve the right balance in setting fiscal policy, due to a track record of prudent fiscal policy, robust financial regulation and strong macroeconomic management and performance, in particular during and since the GFC. The medium‑term focus on fiscal sustainability has provided for short‑term responses to shocks. Australia's resulting low debt levels, combined with a credible strategy to return the budget to surplus, ensure we have considerable flexibility to respond to changing economic conditions. Nonetheless, retaining that flexibility will require ongoing structural improvement to the budget over the years ahead, as economic conditions permit.
This Statement reports on the sustainability of the Government's fiscal position under a range of internationally‑recognised metrics and outlines how the Government intends to maintain the right balance in setting fiscal policy over the short and medium term. The key conclusion is that Australia remains well‑placed in terms of fiscal sustainability, particularly in comparison to most other advanced economies, reinforced by the Government's clear and credible plan to return the budget to surplus.
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