Australia: Selected Issues

Abstract

Australia: Selected Issues

Australia’s Fiscal Framework: Issues and Options for Reform1

Under the current fiscal framework, the Government of Australia is required to report against a medium-term fiscal strategy that is based on principles of sound fiscal management when it presents budgets to Parliament. Since the inception of the framework in 1998, the medium-term strategies have aimed to achieve a budget balance target, on average, over the course of the economic cycle, with a view to control debt accumulation.

In recent years, budget have proposed ambitious fiscal consolidation to achieve a medium-term budget surplus. Budget proposals have typically not presented policies aimed at short-term demand management, a mandate that has been delegated to monetary policy. This approach may no longer be a viable option, as the overnight cash rate may hit its effective lower bound if a large negative shock to activity materializes.

This paper reviews Australia’s current fiscal anchor and framework against the backdrop of a serial misses of some budget targets, raising questions about the framework’s credibility in public debate.

  • Underperformance vis-à-vis hitting the targets is not necessarily a shortcoming of the framework itself, as a weaker-than-expected economy can easily explain the misses.

  • While a testimony to the flexible nature of the framework, clear communication of the reasons behind target misses can preserve the credibility of the framework.

In the absence of strict constraints on governments’ discretion, we propose revising the setting of anchors in the current fiscal framework, using analysis based on the IMF’s model, G20MOD.

Budget repair is required to return to the Government’s medium-term balance anchor although its pace is in question.

  • Overly ambitious budget repair at this juncture poses risks to the recovery and future growth, given primary downside risks from the “new mediocre.”

We recommend replacing medium-term budget balance anchor with a long-term debt anchor.

  • A flexible long-term debt anchor can reinforce the commitment to debt sustainability under both temporary and persistent shocks and still allow for fiscal policy to a play a role in short-term macroeconomic stabilization. The medium-term budget balance anchor is less robust in maintaining long-term sustainability in the face of persistent negative shocks.

  • A medium-term budget balance anchor can still be employed, but only as an intermediate objective. It should be conditional on initial conditions and outlook to be consistent with the long-term debt anchor.

  • The recommended long-term debt anchor can be achieved and maintained by a combination of fiscal rules based on 1) expenditure restrictions and 2) a flexible horizon for converging toward the anchor.

A. Introduction

“The Charter of Budget Honesty provides a framework for the conduct of Government fiscal policy. The purpose of the Charter is to improve fiscal policy outcomes. It requires fiscal strategy to be based on principles of sound fiscal management and facilitates public scrutiny of fiscal policy and performance.”

Charter of Budget Honesty Act 1998 (Commonwealth of Australia, 2014)

1. We review the fiscal anchor and its framework against the backdrop of a sequence of budget targets misses, throwing the credibility of the framework in question. Over the years, the Commonwealth government has announced repeatedly its intentions to achieve its medium-term fiscal strategy, one of reaching and maintaining an annual government surplus of 1 percent of GDP – a medium-term balance anchor – while reducing the size of government. Faced with persistent growth underperformance since 2011 driven by the drop in global iron ore prices, the recession in the mining sector and weakness in other commodities markets, fiscal policy has played a macroeconomic stabilization role, delaying the Government from meeting its stated medium-term objectives, and leading to increased uneasiness about the current fiscal framework.

2. In recent years, the repeated ambitious fiscal consolidation to reach medium-term fiscal targets under a slowly recovering economy highlights the traditional focus on medium-term fiscal objectives. Furthermore, the Government has been less inclined traditionally to deploy more liberally and regularly fiscal policy for short-term stabilization purposes which has meant that monetary policy has had to assume such a role. Current circumstances of weak recovery and low equilibrium interest rates have meant that the conventional monetary policy toolkit is likely to be constrained and alone may not be able to provide the sufficient stimulus in the economy.

3. There are immediate and longer term challenges spanning slower recovery and growth and incipient aging-related spending. Australia is confronted, as are most advanced economies, by the spectre of the “new mediocre,” with the disappointing promise of a sustained lower growth path which is likely to dampen expectations about future growth in the short term. Over the longer term, governments face the persistent challenge of higher spending from demographic pressures related to the ageing of its population.

4. At this juncture, the Commonwealth government budget plans are to meet the medium-term fiscal strategy goals, although we see this as an opportunity to reconsider the fiscal framework. To return to the medium-term fiscal strategy requires budget repair, and then a renewed focus afterwards. We see this as a unique opportunity to evaluate several questions:

  • What is the appropriate response for budget repair with the current medium-term balance anchor, in terms of speed and short-term implementation, given the current outlook, and the downside risk of the “new mediocre?”

  • Is the fiscal anchor still appropriate in the long term, given the dangers inherent in the “new mediocre” and long-term demographic pressures, starting from higher initial debt levels than in the past?

  • What are the possibilities for a new fiscal anchor and its implementation, within a better-defined long-term fiscal strategy?

5. The medium-term anchor is still viable in principle, but an ambitious budget repair strategy risks being destabilizing in the short term. We suggest a mixed spending and tax strategy tilted towards spending measures under a longer adjustment horizon given the current risk from the “new mediocre.” This would entail measures beyond the ones already recognized in Budget 2016-17 (Commonwealth of Australia, 2016).

6. Given the uneasiness surrounding the medium-term balance anchor, we demonstrate that a long-term debt anchor is a good option on which to build a long-term fiscal strategy. A long-term debt anchor can be used to manage efficiently the trade-off between debt sustainability and economic stabilization with the added benefit of reducing uncertainty around the government’s behavior when it is based on a target related to its debt stock, compared to a flow-based approach with less well-defined time horizon. The 2015 Intergenerational Report (Commonwealth of Australia, 2015) highlights that without policy action, spending trends related to demographic issues (primarily health care, aged care and pensions) will lead to an unsustainable situation with a high debt-to-GDP ratio. Our proposed strategy is an explicit long-term debt anchor, based on a flexible response from the tax regime. We demonstrate that a flexible rule to reach the long-term debt anchor can minimize the costs of the transition, even in the response to different shocks, provided that communication of the new long-term strategy is clear. A lack of clarity may be costlier with a long-term anchor, but a clearly stated debt anchor provides greater benefits than one based on the budget balance.

7. The paper is organized as follows. Section B outlines the Australian fiscal framework. Section C looks at the fiscal performance of Australia since the Charter of Budgetary Honesty Act 1998 came into force, with more emphasis on the later years. Section D describes the main features and calibration of the IMF’s macroeconomic model, G20MOD, with an emphasis on fiscal policy and fiscal rules. Section E uses G20MOD to consider how the fiscal authority can meet the stated short-term objective of its fiscal framework. Section F uses the model to examine the transition path to a proposed new long-term strategy as part of the fiscal framework. Concluding comments are in Section G.

B. The Fiscal Policy Framework

8. Fiscal frameworks play an important role to anchor fiscal credibility. The adoption of a sound fiscal framework can help policy makers who are committed to fiscal responsibility, strengthen the institutional basis of their commitment, and signal it to economic agents both domestically and internationally, thus reaping benefits from increased policy credibility. A clear signal of their efficacy would be a favorable assessment provided by the credit rating agencies (Standard and Poor’s, Moody’s and Fitch).

9. Australia follows a principles-based rather than a numerically oriented, rules-based fiscal framework, that provides for “constrained discretion”. The principles are enshrined in the Charter of Budgetary Honesty Act 1998. The Charter provides procedures for setting fiscal objectives and requires extensive fiscal transparency and reporting against a medium-term fiscal strategy. Fiscal objectives are to abide by the Charter’s “Principles of Sound Fiscal Management”. Those are stated in general terms and do not mandate any specific fiscal targets. Moreover, based on these principles, it is left to the government in office to specify budgetary objectives in its fiscal strategy. Fiscal strategy and budgetary objectives are spelled out in a Fiscal Strategy Statement, which is part of the annual budget documentation.

Background on Australia’s Framework

10. There has been remarkable continuity in budgetary objectives, with a budget balance target occupying center stage. Budget balance objectives have been at the center of all governments’ fiscal strategy statements since 1996 – either in the form of a balanced budget over the economic cycle pre-FY2008/09 or a return to a budget surplus of at least 1 percent of GDP in the medium term as part of a post-FY2008/09 “budget repair” strategy.

11. Additional objectives were more time-varying. They related to, for instance, (net) debt or net (financial) worth, caps on the tax share in GDP, and/or a cap on expenditures. A well-specified expenditure objective – limiting real expenditure growth to 2 percent in periods with above-trend growth – was used in the fiscal strategy statements from FY2009/10 to FY2013/14 as part of the exit strategy from the global financial crisis stimulus.

The Current Framework

12. The current framework is built on a medium-term fiscal strategy combined with a short-term budget repair strategy to address deficits born from the global financial crisis. These have both been articulated clearly, and repeatedly in the Commonwealth budgets. They meet the requirements of the Charter. Budget 2016-17 (Commonwealth of Australia, 2016) contains the most recent formulation, and provide useful projections that we use as guideposts in our analysis. The medium-term fiscal strategy properly defines the intentions of the Commonwealth government (referred to hereafter as the ‘Government’), and how they relate to the conduct of fiscal policy. In order to position itself for the medium term, the Government first must bring its budget to a better stance as motivated by the budget repair strategy.

13. The Government’s medium-term fiscal strategy is to achieve budget surpluses, on average, over the business cycle. There are four policy elements (Commonwealth of Australia, 2016, Statement 3, p. 7):

  • “investing in a stronger economy by redirecting Government spending to quality investment to boost productivity and workforce participation;

  • “maintaining strong fiscal discipline by controlling expenditure to reduce the Government’s share of the economy over time in order to free up resources for private investment to drive jobs and economic growth, with: the payments-to-GDP ratio falling; stabilizing and then reducing net debt over time;

  • “supporting revenue growth by supporting policies that drive earnings and economic growth; and

  • “strengthening the Government’s balance sheet by improving net financial worth over time.”

14. Real payments growth over the Government’s forward estimate period (FY2016-17 to FY2019-20) is expected to be 1.9 percent per annum on average, largely surpassed over Treasury’s medium-term forecast period. Over the period from FY2020-21 to FY2026-27, average annual real growth in payments is projected to be around 2.9 percent, around 1 percentage point higher than estimated average real growth in payments over the forward estimates.

15. The Budget repair strategy aims to deliver budget surpluses of at least 1 percent of GDP as soon as possible and will stay in place until the surplus goal is achieved. This is to be achieved by offsetting any new spending measures with other spending cuts. Furthermore, any upward surprises on revenues or spending because of a strengthening economy will be put towards reducing the deficit. “A clear path back to surplus is underpinned by decisions that build over time” (Commonwealth of Australia, 2016, Statement 3, p. 7). The horizon over which to maintain the surplus goal is contingent on sound economic growth prospects and unemployment remaining low. However, the horizon is currently not well defined in Budget 2016-17. In fact, the medium-term projections to the end of FY2019/20 still only see a surplus of 0.1 of GDP, also reflected in the IMF’s October 2016 World Economic Outlook (WEO), which only sees a balanced budget in percent of GDP by the end of 2021.

16. The Intergenerational Report 2015 (Commonwealth of Australia, 2015, referred to hereafter as IGR 2015) is a key part of the Government’s long-term view on the Australian economy. IGR 2015, a report issued by the Commonwealth Treasurer, as mandated by the Charter, is a detailed analytical effort aimed at highlighting the long-term fiscal challenges facing Australia, as a result of the ageing of its population and of other factors likely to boost the demand for some key public services, especially health care and aged care. The IGR 2015 ‘proposed policy’ presents a baseline long-term projection, constructed to highlight the implications for the Government’s finances (in particular the net debt) from the projected long-term ageing of the population, consistent with the policies active at the time of the 2014-2015 Mid-Year Economic and Fiscal Outlook (MYEFO). IGR 2015 further considers alternative scenarios where budget repair is not achieved, or higher productivity and labor force participation help stabilize net public debt at moderately low levels of debt. These scenarios underpin our long-term analysis below.

C. Fiscal Performance

17. The performance of Australia’s current fiscal framework is assessed over three periods, surrounding the global financial crisis (pre-, during, and post- crisis). The current framework began with the Charter of Budget Honesty Act 1998.

18. Before the global financial crisis, the fiscal framework helped maintain the favorable conditions for budgetary surpluses most of the time, further strengthening fiscal sustainability and creating ample fiscal buffers. The initial conditions for implementing a balanced budget rule after the Charter had entered into force were favorable, with the economy growing at potential and the budget already in surplus. Indeed, except for FY2001/02, the balanced budget objective was overachieved (Figure 1). This created very favorable debt dynamics, and the Commonwealth government started to accumulate net assets from FY2003/04, with net asset-to-GDP ratio peaking at 7.3 percent in FY2007/08 (Figure 2).

Figure 1.
Figure 1.

Fiscal Balances 1/

(% of GDP)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Sources: ABS, IMF staff estimates1/ cycl.-adj. = cyclically-adjusted; GG = General consolidated Government; CG = Central Government
Figure 2.
Figure 2.

Debt Dynamics 1/

(% of GDP)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Sources: ABS, IMF staff calculations1/ cycl.-adj. = cyclically-adjusted; GG = General consolidated Government; CG = Central Government

19. However, macroeconomic stabilization was less prevalent as a fiscal objective (Figure 3). In the years preceding the global financial crisis, the fiscal stance at the Commonwealth level (as measured by the cyclically-adjusted primary balance) would appear to have been broadly neutral, with some pro-cyclicality in the last three fiscal years before the crisis at the state government level.

Figure 3.
Figure 3.

The Cyclically Adjusted Primary Balance and Stability 1/

General Government

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Sources: ABS, Commonwealth and State Treasuries1/ GG = General consolidated Government; CG = Central Government; FY = Fiscal Year

20. At the onset of the global financial crisis, considerable fiscal buffers enabled a massive fiscal stimulus. Australia launched one of the most sizeable fiscal stimulus programs among advanced economies of roughly 4.5 percent of GDP. This shifted the path of the Commonwealth deficit firmly into negative territory and reversed the debt trajectory from FY2008/09 onwards.

21. After the crisis, a fiscal repair strategy was put in place, aiming at returning to a budgetary surplus position of 1 percent of GDP in the medium term. In its Updated Economic and Fiscal Outlook of February 2009 (Commonwealth of Australia, 2009, pp. 38-39), the Commonwealth government re-affirmed its commitment to the previous medium-term strategy of achieving budget surpluses, on average, over the economic cycle; keeping taxes as a share of GDP on average below the FY2007/08 level; and improving the government’s net financial worth over the medium term. “Allowing tax receipts to recover naturally” and “reprioritizing spending to fast-track the return to surplus,” were the two planks in return to budget surplus with a view to reducing annual real growth in its spending to 2 percent as economic growth returned to trend.

22. In the first years after the global financial crisis, the repair strategy achieved some reversal of the deficit effect of the stimulus, albeit at the cost of some pro-cyclicality. While budget balance projections have proved to be overly optimistic throughout, mainly due to revenue projections, the Commonwealth deficit was reduced to 2.7 percent of GDP by FY2012/13 on the back of some pro-cyclicality in FY2010/11 to FY2012/13.

23. Since FY2012/13, deficit reduction has stalled and planned consolidation has been repeatedly shifted into the future. After FY2012/13, the deficit has remained elevated, stabilizing slightly above 2.7 percent of GDP, mostly driven by deteriorating revenues from the mining sector. While avoiding pro-cyclicality, it has also entailed a repeated shift of the envisaged trajectory to a surplus of 1 percent of GDP further into the future (Figure 4). More generally, the planned budget consolidation has been based on overly optimistic GDP and revenue projections starting with the post mining bust period (Figure 5). Budget 2016-17 projects a deficit of 0.1 percent of GDP in FY2019/20, relying on revenue projection assumptions akin to previous ones that yielded overestimated revenues, implying a downside risk of high revenues not materializing.

Figure 4.
Figure 4.

Commonwealth Gov’t Deficits

(% of GDP)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Sources: ABS, Commonwealth Treasury, IMF staff estimates and projections.
Figure 5.
Figure 5.

Budget Forecasts of Tax Growth

(% of GDP)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Sources: Commonwealth Budget 2016-17

24. While a postponement of fiscal consolidation may have been warranted on both economic stabilization and sustainability grounds, the repeated underperformance against budget plans and the longer consolidation horizon has weakened the credibility of the fiscal framework. Together with the relatively rapid increase of debt-to-GDP ratios after the global financial crisis and the high share of foreign debt financing, repeated postponement of the consolidation path may have had a negative effect on the credibility of fiscal policy going forward. Indeed, Standard and Poor’s in 2016 have placed the Australian sovereign’s AAA rating outlook at negative, although both Moody’s and Fitch Ratings have confirmed their outlooks as stable.

D. Understanding the Model

25. Our analysis on budget repair and the use of a long-term debt anchor depend on the use of the G20MOD module of the IMF’s Flexible System of Global Models (FSGM). In this section, we discuss the features most salient to our scenarios for Australia. This leads to an extensive discussion of the fiscal rules framework we are using. Finally, we discuss how we calibrate Australia, and the most important interactions with our scenarios.

Brief Overview of the Theoretical Structure 2

26. G20MOD is an annual, multi-region, general equilibrium model of the global economy combining both micro-founded and reduced-form formulations of various economic sectors. Structurally, each country/regional block is close to identical, but with potentially different key steady-state ratios and behavioral parameters. Real GDP in the model is determined by the sum of its aggregate demand components in the short term, and the level of potential output in the long term. Aggregate demand follows the standard national expenditure accounts identity. Components such as household consumption and private investment are based on optimizing behavior, while trade is of a more semi-structural nature, and government is mostly exogenously specified. The two key prices in the model is the consumer price index (CPI) and wages, modeled by inflation and wage inflation Phillips’ curves, respectively. The commodities sector consisting of oil, metals and food is modelled on both a global and country basis, with metals playing an important role in Australia. The fiscal sector is also fairly comprehensive, and while the financial sector is fairly simple, it does provide a role in the model for both a 1-year interest rate, which serves as the short-term instrument for monetary policy, and a 10-year interest rate. The external sector is based on aggregate trade of countries with the rest of the world, instead of tracking individual bilateral relationships.

27. The key feature on the demand side is a consumption block based on the Blanchard-Weil-Yaari overlapping generations (OLG) model (Blanchard, 1985; Weil, 1989; and Yaari, 1965). Using OLG households rather than infinitely-lived households results in important non-Ricardian properties whereby the path for government debt has significant economic implications. In the OLG framework, households treat government bonds as wealth since there is a chance that the associated tax liabilities will fall due beyond their expected lifetimes. The OLG formulation results in the endogenous determination of national saving and the demand for net foreign assets given the level of government debt. The global real interest rate adjusts in the long-term to equilibrate the global supply of and demand for savings. The central role for government debt allows for a powerful role for fiscal policy in the long term, not just in the short term. There are also households who only consume out of current income and are considered liquidity-constrained (LIQ) households

Fiscal Policy

28. Fiscal policy is driven by a sufficiently detailed government sector that can reproduce simplified fiscal accounts for each country. Eight policy instruments are featured. On the spending side, in addition to government consumption and infrastructure spending, there are general lumpsum transfers to all households (such as pensions, aged care provisions, unemployment insurance) and lumpsum transfers targeted to LIQ households (such as welfare, certain pensions). On the revenues side, there are taxes on consumption (the goods and services tax, GST), personal income (PIT, on both wage and dividend income) and company income (CIT), as well as taxes and royalties from the mining and production of metals. For Australia, the government is an amalgam of the Commonwealth and State governments. However, many of the issues in this paper focus on the Commonwealth accounts and balances.

29. The budget constraint in the model is met by the choice of a long-term deficit target, relative to GDP. Specifically, the deficit is expenditures and interest payments, less revenues. One instrument, which is general lumpsum transfers by default, is constantly adjusted to make sure that the budget constraint always holds. The long-term government debt target, relative to GDP, can be derived from the government deficit target, based on the nominal growth rate of the economy:

btar=(1+π)(1+g)(1+π)(1+g)1gdeftar

where π is inflation, g is the steady-state growth rate, btar is the long-term debt target, and gdeftar is the long-term deficit target. The explicit deficit target therefore pins down the long-term government debt, a fundamental decision variable for firms and households worldwide. The level of government debt affects the global interest rate (the price used to equilibrate global saving with global investment), and the real exchange rate (a country’s relative price for its contributions and use of the global saving-investment pool).

Fiscal Rules

30. We introduce the concept of a fiscal rule, to lay the groundwork for both the model and the ensuing analysis. The use of the deficit target to implement a stable government-debt-to-GDP ratio is a fiscal rule, for instance. In following the terminology used in IMF (2009), three primary fiscal rules of concern in this paper are pursued.

  • Expenditure rule (ER) – The government specifies some restriction on some component of spending to provide control. The ER does not directly provide any restriction to the budget balance, as it does not imply any particular restriction on the revenue side of the economy, or its borrowing intentions.

  • Budget balance rule (BBR) – The government specifies some restriction to ensure the budget meets a particular target level after some time horizon. A balanced budget (where the deficit is zero) is special case of a BBR. The BBR also implies a long-term debt level (see the equation above relating the deficit and debt targets), but this is not a required consideration for the choice or implementation of its particular form.

  • Debt rule (DR) – brings the government debt to some particular target level after some time horizon.

31. The BBR and the DR can be either strict or flexible. ‘Strict’ means the target level for the BBR or the target path for the DR is met in full each year. If it is ‘flexible’, the BBR’s target level or the DR’s target path is met on average over some particular time horizon – for example, “over the business cycle” or “over the course of three years.”

32. G20MOD’s deficit target is a strict BBR, which at the same time embeds a short-term feature which provides some flexibility. The government has legal obligations to provide social transfers (such as unemployment insurance, or welfare). These are part of the general lumpsum transfers in G20MOD intended to smooth the business cycle (i.e. provide more unemployment insurance in the recessionary phase of excess supply, and less in the expansionary phase of excess demand). Therefore, under this strict BBR, the deficit-to-GDP target translates into the deficit-to-GDP ratio gdefrat, while allowing for flexibility:

gdefrat=gdeftardygapygap

where dygap is the countercyclical weight on the measure of the output gap, ygap. In referring to the automatic social transfers below, these are related to the additional spending (or saving) that is always added to general lumpsum transfers.

Calibrating the Australian Economy

33. We describe below the salient parameter values for G20MOD as used in this paper. Most of the parameters are calibrated for the model as a whole, using the process explained in Andrle and others (2015). Some of the baseline data is also key for the behavior of the Australian economy, particularly the share of the commodity sectors, and their trade relationships with the rest of the world. Calibration is informed by estimation work from older versions of the model, stylized facts, and properties of the IMF’s other structural macroeconomic models. The goal is to obtain sensible system-wide properties. Given that we are calibrating a steady state in the model, the numbers may not match raw data in quantity, but should qualitatively capture their significance.

The External Sector and Commodities

34. The most important factors in calibrating Australia’s external sector are data related to its size (Table 1). Australia has a small share of global GDP – approximately 1.6 percent. Its permanent fiscal shocks have little impact on global real interest rates (unlike the United States or euro area, for example). However, it is a large market participant in the global metals market (consisting of aluminum, copper, iron, lead, nickel, tin, uranium, and zinc in G20MOD), with a 13.6 percent share of global production. Resources combine for roughly 9.1 percent of Australian real GDP, and are slightly below conventional calibrations of 10 to 15 percent of GDP, as the G20MOD basket is limited in its coverage.

Table 1.

External Sector Calibration

article image
Sources: IMF staff calculations and World Economic Outlook

35. Australia’s openness is key in determining how activity in the rest of the world (in particular, China) spill over onto it, and how Australia influences the rest of the world. Australia exports about 24.6 percent of GDP, and imports 23.5 percent of GDP which is marginally below the G-20 average of 26.6 and 26.9 percent of GDP, respectively. Compare this with the United States, a less open economy, with ratios of 17.3 and 16.2 percent of GDP, respectively. Under openness, monetary and fiscal policy actions have a large leakage component. For example, a 1 percent increase in the nominal 1-year interest rate only decreases real GDP by 0.3 percent in Australia, versus 0.4 percent in the case of the United States. Similarly, a two-year real GDP multiplier for government consumption for Australia is merely 0.62, versus 0.71 for the United States.

36. We pay special attention to the metals sector. The real global metals price is governed by a global equation with both production and global demand effects proxied by output gaps. The measure for demand responsiveness is weighted by metal consumption weights, and for supply responsiveness by metal production weights. The level of the metals price and the parameters governing its price dynamics and dynamics caused by reactions to metals price movements are consistent with the October 2016 WEO metals price. In Australia, we calibrated the share of metals royalties and resource taxes to be 0.75 percent of GDP, which can potentially be a source of procyclical volatility from the fiscal revenue side. As metals demand expands or the metals price increases, usually in tandem with a domestic economic expansion, royalties increase and allow further government spending for a fixed debt target. The opposite is true in a recession. Given the magnitude of royalties, this effect is second order, and is not a prime driver of the scenarios discussed below.

The Domestic Economy

37. Australia’s economy is calibrated using roughly current national accounts ratios and fiscal ratios with G-20 ratios reported to provide contrast (Table 2). Several features are notable. First, Australia draws much more of its tax income from corporate taxes as a percent of GDP relative to the rest of the G-20. Second, the net foreign liability position is large relative to the G-20, so U.S. interest rate shocks can pose a greater threat in G20MOD to Australia than other countries. Finally, they have low general consolidated government debt on a net basis (only 20 percent of GDP) relative to the rest of the G-20, so shocks do not have as strong effects in Australia on government interest payments as in other countries.

Table 2.

General G20MOD Calibration

article image

G-20 average uses G-20 debtor countries only

Sources: IMF staff calculations, World Economic Outlook and GFS

38. Much of the parameterization for Australia’s behavior is the same as the other advanced economies in G20MOD. This is the standard approach to calibration for parameters such as the intertemporal elasticity of substitution (governing the dynamics and speed of the current account response because of the shift between consumption and private saving) and the share of LIQ households, which is at the standard 35 percent. Similarly, the price and wage Phillips’ curves (lead and lag on inflation; the output gap) are calibrated the same as the non-European advanced economies, and the financial accelerator matches that of the other advanced economies.

Fiscal Rules

39. Fiscal rules in G20MOD have both a short-term and long-term component. The short-term component is automatic social transfers, whereby the level of general lumpsum transfers are negatively correlated with the output gap, given shifts in other tax bases and spending components, as found in Girouard and André (2005), Table 9. The average value of this correlation for advanced OECD countries is 0.44, while that of Australia is 0.39. The long-term component is either the general consolidated government deficit or debt as a ratio of nominal GDP. The deficit-to-GDP target is used for the strict BBR, and the debt-to-GDP target for the strict DR. The government sets its deficit or debt as a target ratio to GDP (with an additional adjustment for the short-term automatic social transfers) and by choosing to adjust one instrument such that the government budget constraint always holds. The flexible rules move the adjusting fiscal instrument based on the deviations of the actual deficit- or debt-to-GDP ratios from their targets (a deficit or debt gap). The lower the weight on a deficit or debt gap, the longer it takes for a rule to achieve its target.

40. The flexible BBR and DR have a more complex structure and calibration. For a flexible rule, the deficit is endogenous, and a chosen instrument reacts directly to the deficit and/or debt gap. For the flexible BBR, there is only a weight on the deficit gap, of 0.8. For the flexible DR, there is a weight on both the debt gap and the deficit gap. The weight on the debt gap is the inverse of the number of years (0.1 for 10 years, 0.2 for 5 years), which controls the rate at which debt returns to its target. The weight on the deficit gap is 0.25, with the flexible DR using the first difference of the debt-to-GDP ratio to help minimize the general volatility of the economy as the debt-to-GDP ratio adjusts.

E. Achieving the Medium-Term Balance Anchor through Budget Repair

41. In the short term, the Government is committed to achieving its medium-term balance anchor of +1 percent of GDP, through the process of budget repair. However, by 2021 (FY2020/21), the October 2016 WEO projects a government balanced budget (zero percent of GDP), short of the 1 percent target. We therefore analyze what adjustments are needed now in meeting that target and in setting the stage for further comprehensive long-term adjustments.

42. The required budget repair is +1 percent of GDP relative to the WEO baseline. In illustrating how this gap might be closed, we propose to achieve 25 percent of this by increasing the GST at some date from the revenue side, and 75 percent from the spending side, split evenly between government consumption and general transfers, phased in linearly over 30 years. With regard to the GST adjustment, two time horizons are considered: 5 years, with an immediate increase in the GST so that the medium-term balance anchor is achieved by FY2020/21; and 10 years, with an increase in the GST introduced only after five years so the medium-term balance anchor is achieved by FY2025/26.

43. The contemplated baseline scenario is fairly benign, with continued strength in real GDP and revenue growth and moderate spending pressures in the short-term, but not without risks. However, under a current environment, risks are skewed to the downside, of uppermost concern is the “new mediocre.” In the case of Australia, the “new mediocre” can be described as spillovers from global secular stagnation, which results in a permanent decline in global metals prices. Such global factors may cause a localized version of secular stagnation, coupled with a further decline in Australia’s terms of trade (See Box 1). Given the considerable uncertainty surrounding forecast, we analyze achieving the medium-term balance anchor under both environments, using an illustrative scenario for the “new mediocre”.

The “New Mediocre” and its Implications on Australia

The illustrative version of the “new mediocre” we consider is summarized in the accompanying figure. In the case of Australia, it can be described as secular stagnation, where households and firms realize that future productivity will be lower than originally expected. On a global scale, secular stagnation permanently drives down global metals demand, which is a negative terms-of-trade shock for Australia. The government deficit moves in tandem with changes in revenues and expenditures – tax rates are exogenous, as is spending, except for the automatic social transfers.

The “new mediocre” is basically a realization that ongoing productivity growth will be lower than originally anticipated by households and firms. It is akin to a negative productivity shock. There is lower demand for factors of production, so the capital stock and investment contract. There is also lower labor income and wealth. Goods cost more to produce, lowering consumption for a given level of income, leading to a contraction of real GDP. The Australian dollar also appreciates by about 1.5 percent, so supply contracts in response, and there is a shortage of goods to meet foreign demand.

We assume it is exacerbated by a decline in the global price of metals due to weaker global demand which negatively affects Australia’s terms of trade. There is a further contraction of metals production from the lack of global demand and price pressures that make it more difficult to meet production costs. This is a negative wealth shock, and there are negative implications on consumer spending, and harmful second round effects. Overall, real GDP contracts by 1.5 percent relative to baseline after 10 years, led by large declines in consumption and investment (2.1 and 2 percent, respectively).

The Government also faces strains in its balance, and monetary policy is assumed to have room for easing. The Government faces higher spending from automatic social transfers, and downward pressure on tax revenues as a result of both a general contraction of the tax bases and weaker royalties and resource taxes. This raises the deficit by 0.5 percent of GDP by the second year, and 0.8 percent of GDP by the tenth. In playing a supporting role to weaknesses in demand, monetary policy is deployed with the RBA only needing to cut the overnight cash rate by around 30 basis points at its trough in the second year. However, under increased probability of hitting the effective lower bound on interest rate, the RBA may be constrained in cutting rates further and given that this is a negative permanent supply shock, the RBA can only smooth, but not prevent, the downward decline in the economy.

A03ufig1

The “New Mediocre”

(Percent deviation from baseline, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

44. Therefore, we can consider that budget repair is at a risky juncture (Figure 6). We consider the cases for budget repair that take either 5 years or 10 years, under both the baseline and “new mediocre” scenarios. Under both cases, the external sector has a large influence on the results and favors the five-year horizon. For consumption, the ten-year option is more favorable, as the GST increase is delayed, by construction. In both scenarios, consumption falls, by about 0.8 percent relative to baseline, and about 1.0 percent relative to the “new mediocre”. This is not the case for investment, which sees a generally higher cost of capital, as the presence of a zero or negative output gap indicates a worse environment for firms’ financial health, thereby raising the corporate interest rate. But the fall in investment is temporary, albeit worse in the 10-year case, and worse under the “new mediocre”, in the fourth year – an additional 1.0 percent relative to the “new mediocre” versus about -0.6 percent relative to baseline.

Figure 6.
Figure 6.

Budget Repair at a Risky Juncture

(Percent deviation from baseline, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

45. The reduction in government debt leads to a lesser availability of domestic assets for households. To maintain their desired level of financial wealth, households seek more foreign assets, in turn reducing net foreign liabilities, requiring a higher current account (through net exports) in the short-term. This encourages a real exchange rate depreciation in the magnitude of about 0.6 percent under the 10-year case relative to baseline, or 2.6 percent under the 5-year case.

46. In terms of its impact on the economy, the adjustment process yields more substantive positive effects under 5-year repair in light of the more rapid consolidation. It leads to a higher trade balance in the near-term, causing a larger depreciation. Higher net exports also lead to excess demand and therefore inflationary pressures, leading to tighter monetary policy via an increase in the overnight cash rate. The excess demand also reduces investment risk as firms have a lower probability of default and firms actually face lower corporate interest rates compared with repair under the longer 10-year horizon.

47. As an offset to the short-term costs as a result of adjustment over either the five- or ten-year horizon, infrastructure investment is introduced. There is a small increase in deficit-financed spending devoted to infrastructure investment (of 0.25 percent of GDP for each of the first two years) which is a direct stimulus to real GDP through government absorption. This spending is likely to buttress productivity at a time of falling capacity. It also encourages a larger real exchange rate depreciation, which further magnifies the positive effects in the external sector. Nonetheless, in light of it size effect, it does little to counteract the large short-term impacts if a risk such as the “new mediocre” were to materialize.

48. In conclusion, budget repair may be difficult to carry out fully at this juncture. There is uncertainty on the required magnitude for budget repair, since it is dependent on revenue forecasts. These forecasts, as shown in Section C, have a history of being over-optimistic, so the required amount for budget repair could practically be larger than 1 percent of GDP. Furthermore, budget repair is relying on rebalancing of the Australian economy, shifting to the external sector from the domestic sector, which may not be a desired outcome for the Government. This is also why a shorter horizon works better, as it takes advantage of a quick external sector adjustment, where the larger depreciation offsets the larger consumption contraction.

49. Regardless, budget repair under the “new mediocre” could also prove to be a much costlier endeavor than what it entails in terms of attaining the 1 percent surplus target. Beyond the initial required adjustment in the magnitude of an equivalent 1 percent of GDP improvement in the budget balance, the automatic social transfers and weaker tax base effects, estimated at 0.9 percent of GDP in our illustrative scenario, need to also be offset. Budget repair in such an environment would also prevent the Government from engaging in additional stimulus, which is not consistent with its historical stimulative behavior under economic stress– for example, the estimated 4.5 percent of GDP fiscal impulse at the onset of the global financial crisis in FY2008/09.

F. Suggesting a New Long-Term Fiscal Strategy

50. Once the desired medium-term balance anchor has been achieved, we can turn to issues of stabilizing the long-term level of debt on a sustainable basis. We propose an extension to the current fiscal framework, with the introduction of a long-term debt anchor. In better explaining the motivation and analysis of such strategy, this is done over four parts. First, we discuss the long-term spending pressures that motivate the extension to a long-term anchor. Second, we compare the efficacy of a long-term debt anchor to that of the existing medium-term balance anchor under three illustrative scenarios, namely an unexpected and substantial pick-up in aggregate demand, a boom-bust cycle related to swings in the global price of metals, and the “new mediocre,” using a set of metrics related to debt sustainability and economic stability. Third, we show ways of implementing the long-term debt anchor, based on combinations of an expenditure-debt rule under differing speeds of adjustment to achieve the debt target. We consider this under an optimized mix of indirect versus direct taxes setting. Fourth, we conduct again the aggregate demand scenario and boom-bust cycle from the second part to better elucidate the strengths of the fiscal rules under consideration once again using the set of metric mentioned above. We conclude our analysis by looking at potential short-term effects of clear and credible communication on the adjustment process.

Long-Term Spending Pressures from Demographics

51. Long-term pressures on the budget related to primarily demographic issues such as health care, aged care, and pensions are looming. By 2050, IGR 2015 estimates that the Government will have to spend an additional 2.5 percent of GDP on such outlays. Even assuming a linear trend starting from zero in 2021, and reaching its long-term value after 30 years, we estimate this to add up to 21 percent of GDP of net debt in 2050. Moreover, in the very long term, net debt would stabilize after increasing by a whopping 58 percent of GDP. This is referred to below as the ‘No Policy Action Scenario’.

52. Apart from consolidation, there are measures available to the Government that could lessen the pressure on the Australian economy. In this regard, revenue-neutral tax switching is proposed. While it does not prevent the large run-up in debt, it does ameliorate the situation somewhat, and strengthen domestic demand in face of the crowding out effects of increased government demand for funds in the economy. We propose a reduction in direct taxes – the CIT by 0.7 percent of GDP, the PIT by 1.4 percent of GDP – offset by an equivalent GST increase worth 2.1 percent of GDP, similar to that proposed in Pitt (2015). This is referred to below (and in Box 2) as the ‘Tax Switching Scenario’, which embeds the no policy action scenario.

53. Given that this tax strategy does not reduce the debt burden significantly, we further propose the fiscal consolidation required to achieve debt control. For simplicity, to contain the costs that could result, we consider cuts in other lumpsum transfers, outside of aged care and pensions. The government adheres to a balanced budget, aside from allowing for the effects of automatic social transfers. We refer to this as the ‘Simple Balanced Budget Scenario’ which builds on the tax switching scenario.

54. We see in the No Policy Action Scenario that real GDP is stronger by less than 1 percent after 30 years (Figure 7), This is despite the strong increase in general transfers, which feed directly into household consumption, which increases in the long-term by about 2 percent. Not only does the spending have an immediate impact on LIQ households, but it also changes the consumption profile of OLG households, given the inevitable and inexorable path of spending increases. Private investment, on the other hand, suffers as it is crowded out by government debt, holding roughly at 0 percent relative to baseline in the long term. Nonetheless, the additional consumption demand stimulates the supply side on the economy, and increases demand for both capital and labor as factors of production.

Figure 7.
Figure 7.

Long-Term Spending Pressures

(Percent deviation from baseline, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

55. The new spending increases government debt, which is dissaving, increasing the demand for foreign financing, with overall little changes in GDP. This increases the Australian net foreign liability position further, by about 20 percent of GDP, and lowers the current account, thereby supporting a notable real appreciation of around 2 percent relative to baseline in the long term. There is a rebalancing between the domestic and external sectors, with a worsening net trade position offsetting the strength in consumption. Overall, real GDP barely changes.

56. Under the Tax Switching Scenario, the long-term positive effects of PIT and CIT cuts are greater than the equivalent increase in the GST and confer strong positive effects on real GDP (Box 2). The CIT cut has a direct positive impact on investment demand, while the PIT cut works to increase labor supply and income.. Indirect effects from PIT and CIT also play an important role in decreasing costs for firms, stimulating potential output, and generating positive effects on wealth through the capital stock and labor income. The GST increase works against consumption, and offsets some of the positive impacts of both the PIT and CIT cuts. In aggregate, consumption gains 0.5 percentage points, and investment gains 4.0 percentage points so that real GDP is about 1.4 percentage points higher, all relative to the No Policy Action Scenario.

57. Since the tax switching acts as a positive supply shock, the output gap goes into excess supply before rising as the expansion becomes more general. However, there are positive inflationary pressures from higher demand on impact, leading the RBA to increase the overnight cash rate by over 50 basis points to maintain inflation on target. In the short term, the RBA could play a role in amplifying the positive effects from the tax switching regime by changing the overnight cash rate, thereby preventing some of the rebalancing against the domestic sector.

Decomposition of the Tax Switching Scenario

We decompose the tax switching scenario into two components. First we consider a switch from the CIT to the PIT (on both wage and dividend income) of 0.7 percent of GDP. Second, we analyze a further switch from PIT (on wage income alone) to GST, of 2.1 percent of GDP. A roughly linear combination of these two switches give us the results for the Tax Switching Scenario in Figure 7. A key point to remember that PIT is not only payable on all households’ wage income, but also on dividend income, exclusively received by OLG households.

First, we consider the switch from CIT to PIT. When the CIT is cut, OLG households will receive fewer franked dividends, and automatically face a greater tax liability for their dividend income (see the fiscal section of Appendix I for a discussion of franking). There will be only a slight increase in taxes on wages, and dividend income will bear the brunt of the PIT increase. When the cut in CIT is netted with the aggregate increase in PIT, the increase in investment outweighs the direct negative impact of the PIT shift on consumption, which is offset within the first 5 years.

Second, we consider a further switch from PIT to GST. For the second part of the scenario we decrease the wage portion of the PIT (instead of increasing it), in order to offset it with a 2.1 percent of GDP increase in the GST. Because the GST increase dampens consumption for both OLG and LIQ households immediately, but the PIT cut serves to stimulate it, we find that the effect on real GDP is relatively weak at 0.3 percent of GDP – a small multiplier of 0.14. This is in line with work presented by the Treasury (Commonwealth of Australia, 2016).

A03ufig2

Tax Switching

(Percent deviation from baseline, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

58. Under the Balanced Budget Scenario, a key channel is the crowding in of private investment, as private saving and foreign assets are no longer being diverted to the government. Furthermore, the embedded tax switching acts to arrest the rebalancing of the economy towards the external sector, encouraging an expansionary depreciation of 1.2 percent relative to baseline in the long term. Import compression occurs, but is offset by the expansion that is occurring from private investment, which happens to be more import-intensive than household consumption.

59. Going forward, the No Policy Action Scenario is our Benchmark Scenario. To summarize, under the Benchmark Scenario, if nothing is done to offset future spending pressures, net government debt and the net foreign liabilities position deteriorate in the medium term. Under such a benchmark, additional possible risks, such as sovereign risk premia that would raise the government’s borrowing costs, and possibly that of the economy as a whole, further crowding out investment and discouraging consumption are not explored.

60. We posit that we can improve outcomes with a government-debt-to-GDP target as a long-term anchor. To achieve this, a long-term fiscal strategy is required. To illustrate, we carry out our analysis under a constructed environment, where the benchmark scenario is taken as given, with its large run-up in debt, and examine the reaction of the economy to the implementation of the long-term anchor over the medium-term horizon of 2021 to 2050. The tax switching is maintained in attempt to better position future fiscal actions. Our method is analyzing a debt norm – considered to be a reduction of net government debt by 10 percent of GDP - to better elucidate the costs and benefits involved. We intend to demonstrate that there are benefits to a long-term debt anchor, and to that we now turn.

The Argument for a Long-Term Debt Anchor

61. A long-term debt anchor provides certainty for households and firms in their decision making. Just as price stability removes uncertainty about the nominal economy, a set debt target removes a significant source of uncertainty about the real economy. Government debt is a vital part of wealth holdings by households. It also crowds in or out net foreign liabilities (through its flow, the current account) and capital stock (through its flow, investment). Therefore, a long-term debt anchor (a stock concept) helps stabilize the Australian economy in a way which the medium-term deficit anchor (a flow concept) cannot. The adoption of a long-term debt anchor can help governments which are committed to fiscal responsibility strengthen the institutional basis of their commitment, and signal it domestically and internationally, thus reaping benefits from increased policy credibility.

62. We assess whether the long-term debt anchor performs better than the medium-term balance anchor when faced with economic surprises, under different scenarios. We consider three illustrative scenarios that cover both demand and supply disturbances, that can be regarded as possible upside and downside risks:

  1. A temporary but substantial increase in aggregate demand (Box 3). We assume that aggregate demand turns out to be stronger than expected by about 2 percent of GDP at its peak in year 3.

  2. A terms-of-trade-driven boom-bust cycle (Box 4). We build a term-of-trade boom-bust cycle by imposing a path of real global metals prices that loosely matches the changes in the RBA’s Index of Commodity Prices.

  3. The “new mediocre” (Box 1): We consider again the combined secular stagnation and permanent negative terms-of-trade shock. While a risk, it can be argued that it may not unfold for years to come. It is important to understand that the shock is a negative one to future expectations, and not a well incorporated and understood decline in outcomes by forward-looking households and firms.

63. We analyze three different fiscal rules to draw our conclusions. Under the first considered rule, a current medium-term balance anchor is held over the course of the business cycle; this is interpreted as a flexible BBR over 7 years (flex BR in Table 3 below). Two debt rules (DR) are then deployed in attempt to achieve the long-term debt anchor – one strictly holds debt at its target (strict DR) and the other achieves the debt target flexibly, consistent with a 10-year horizon (flex DR (10 yrs)), as shown in Table 3 below.

Table 3.

The Long-Term versus the Medium-Term Anchor

article image
Sources: IMF staff estimates and calculations

64. Evaluating the relative performance of the fiscal rules is based on five indicators. As guiding principles, rules are evaluated against achieving debt control (debt reduction along a debt norm path) and economic stabilization (primarily their degree of countercyclicality), based on the methodology presented in Kinda (2015). Debt control should have a degree of flexibility, which is measured by the root mean squared deviation (RMSD) from the debt norm; the further from 0, the more debt can respond under a rule to any given shock, which should minimize additional adverse impacts on real GDP. Debt control is also a matter of precision, which can easily be measured as the deviation from target as a particular year (here, 10 years by 2030) and also by the absolute mean deviation of debt from the debt norm path where closer to 0 is preferred. On the other hand, economic stabilization can be captured by the variability of real GDP over 10 years (where closer to zero is preferred) and by a measure of procyclicality.

A Temporary but Substantial Increase in Aggregate Demand

We consider a temporary but substantial increase in aggregate demand. Real GDP peaks at over 1.6 percent above the baseline in the third year. Investment movements are significantly more sizeable than consumption (in the order of four times) relative to baseline. The government deficit moves in tandem with changes in revenues and expenditures – tax rates are exogenous, as is spending, except for the automatic social transfers.

Monetary policy plays a key role. As the economy enters excess demand (the output gap is greater than zero), there are upward pressures on inflation, which must be addressed by the RBA in achieving its mandate of price stability. They increase the policy rate by 2.5 percent by the second year, and maintain it an elevated level into the fifth year.

Economic growth results in a strong debt consolidation. The government deficit falls by almost 0.9 percent of GDP in the second year.

Elsewhere in the economy, the external sector worsens. Import demand is higher, encouraged by the upward pressure exerted by monetary policy on the real exchange rate. Here, we are assuming fiscal policy follows the simple balanced budget rule and reduces social transfers, meaning fiscal policy is countercyclical and works against the increase in aggregate demand.

A03ufig3

(Percent deviation from baseline, unless otherwise stated!

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

A Terms-of-Trade-Driven Boom-Bust Cycle

The terms-of-trade-driven boom-bust cycle causes substantial disruptions over the first ten years. As is the case with most boom-bust cycles, we assume that during the boom years, there is only an expectation that commodity prices will stabilize; there is no prescience of a collapse (as in Rees and others, 2015). This makes the downturn that much more disruptive for the economy in general, and investment in particular. The government deficit moves in tandem with changes in revenues and expenditures – tax rates are exogenous, as is spending, except for the automatic social transfers.

The boom-bust cycle is strongly reflected in real GDP fluctuations. There is a continuing upward expansion in the first 4 years, then as real global metals prices unexpectedly unwind and undershoot their long-term trend, real GDP weakens and contracts before strengthening to return to its trend path after about 10 years.

In the first part of the cycle, there are highly expansionary wealth effects which encourage private investment. The follow-up contraction leads to a fall in investment, falling to 2.6 percent below baseline in the sixth year from its peak of 2.2 percent above the baseline in the third year. Investment is also the driver for the behavior of imports. Note that the investment response is different from the current boom-bust cycle, which had a large infrastructure component for mining. We assume that the current infrastructure will be sufficient to accommodate another boom, and will not cause an additional investment response.

The rapid appreciation is part of the commodity price cycle, which generates a wealth transfer to commodity exporters such as Australia, while the converse is true during the downturn, with a large depreciation. In the case of non-mining exports, the exchange rate is the dominant influence, so they first contract during the economic boom, and expand during the downturn. Therefore, non-mining exports are countercyclical and help stabilize the economy to some degree.

Monetary policy works to smooth the cycle. Since a boom-bust cycle is a classic aggregate demand shock, inflation first rises then falls, meaning that the cash rate cycles in the same way, peaking at +50 basis points in the second year, before troughing at -50 basis points in the fifth year, relative to baseline.

A03ufig4

(Percent deviation from baseline, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

65. The measure of procyclicality is centered around zero, comparing the change in the primary surplus with that of the change in the output gap. Fiscal policy is considered procyclical if the output gap becomes more positive (negative) and primary surplus decreases (increases), then. The preference is for countercyclicality, where the primary surplus and the output gap are positively correlated, where fiscal policy works on smoothing business cycle movements, and provides economic stabilization.

66. In summarizing the results, we argue that the long-term debt anchor outperforms the medium-term balance anchor (Table 3). The RMSD shows that there is more flexibility (debt would respond better to shocks) under the flexible debt rule, as can the medium-term balance anchor. The debt rule is more precise in the long-term, as shown by the lower value for the AMD for both debt rules. We also learn that real output is less variable under the debt rules implying more certainty of the outcome and more rapid adjustment on the part of households and firms as they make their behavioral choices. By design, the DR achieves faster convergence to the desired debt-to-GDP ratio. Furthermore, the medium-term debt anchor is more countercyclical, but flexible DR also demonstrates notable countercyclicality. Given the fact we do not capture the uncertainty inherent in the long-term end-point in the announced medium-term balance anchor in the results here, the long-term debt anchor under the flexible DR performs strongly.

Implementing the Long-Term Debt Anchor with Fiscal Rules

67. To implement the long-term debt anchor requires a long-term fiscal strategy. In practice, there should be a consolidation plan to support both macro and fiscal stability. The outcome should be that real GDP would be larger and debt would be expected to be more sustainable than otherwise. To support a long-term debt anchor, and take full advantage of its power, there should be a regime based on an aggregated rule that is a composite of explicit fiscal rules. The component fiscal rules need to be appropriate to macro-fiscal conditions and institutional settings.

68. The rationale for adopting legislated numerical fiscal rules can be weaker in a country like Australia. It has a well-established record of responsible fiscal policies under Governments of different political ideologies. The question is how do the potential benefits of a clearly and specifically defined fiscal policy targets backed by a stronger legal basis compare with their potential costs. We also recognize that fiscal rules are not a panacea. They involve delicate trade-offs between ensuring inter-temporal consistency in the conduct of fiscal policy, and garnering an appropriate degree of flexibility in fiscal management (ensuring a scope for countercyclical policy and the full operation of automatic social transfers). These trade-offs can be moderated, through an appropriate design of the rules, such as the inclusion of escape and revision clauses. Such flexibility generates better growth and debt outcomes, and governs the choices on the rules we implement below.

69. We analyze the aggregated fiscal rules under an intuitively constructed environment. Our medium-term target horizon extends between 2021 and 2050, taking the benchmark scenario as given, with its large run-up in debt. We implement tax switching to better position future actions. Our analysis is then based on a debt norm, defined as a reduction in net debt of 10 percent of GDP relative to the benchmark scenario, in better tracking the costs and benefits under consideration. This is treated to be the ‘benchmark consolidation’ case.

70. For our analysis, we construct three different aggregated rules. We draw components from the different types of fiscal rules, as defined in Section D. Guided by both Budget 2016-17 and IGR 2015, we focus on the component rules deemed most relevant to the Australian situation:

  • An expenditure rule (ER) – We assume that government consumption and general transfers grow at only 2 percent a year for 10 years starting in 2021, roughly consistent with the average over the WEO horizon extending from 2016 to 2020. This is also in line with the Government’s stated goal of reducing the size of government. Relative to Budget 2016-17, this means a reduction spending growth by 0.9 percentage points each year.

  • Variants of a debt rule (DR) – We meet the long-term government debt target after 5 or 10 years by varying the GST rate to achieve the debt norm of 10 percent, with either a strict or flexible pursuit of the debt norm path from 2021 to 2050.

Given these component rules, we choose three aggregated fiscal rules:

  • ER + strict DR, where 90 percent of debt norm is achieved by 2030, with a strict adherence to the debt target each year;

  • ER + flexible DR, where 90 percent of debt norm is achieved by 2030 (over 10 years) allowing for some variability in debt that is consistent with an average business cycle frequency of six to seven years, further implying an average decrease in the deficit of around 1 percent of GDP relative to the ‘benchmark scenario’; and

  • ER + flexible DR, where 90 percent of debt norm is achieved by 2025 (over 5 years) allowing for some variability in debt that is consistent with an average business cycle frequency of six to seven years, and an average decrease in the deficit of around 2 percent of GDP relative to the ‘benchmark scenario’.

71. In the benchmark consolidation, real GDP is always stronger, thanks to the embedded tax switching strategy (Figure 8). However, there are short-term downward pressures from the consolidation. The profiles of real GDP depend on the rule in force. The shorter time horizon of 5 years inflicts the largest near-term costs, while the more flexible rules allow real GDP to react positively to the tax switching, with debt reacting more gradually to it and to the expenditure rule.

Figure 8.
Figure 8.

The Benchmark Consolidation

(Percent deviation from the No Policy Action Scenario, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

72. The components of domestic demand act at cross purposes in the short term. Consumption is weakened by the increase in GST to pursue debt reduction, dominating the positive effects from the PIT cut. At the same time, private investment is stronger because of the lower CIT, with further crowding in from the reduction in government dissaving. This dichotomy is reinforced by the DR with 5-year adjustment.

73. In the short-term monetary policy acts as a drag, except under the five-year horizon. The RBA works to maintain its inflation target, which smooths the path of real GDP. The GST is increased so much under the DR that weakness in consumption is disinflationary, and the RBA increases the overnight cash rate less on impact, followed actually by further cuts in the medium term.

74. In the long term, the components of domestic demand move in one direction. The positive investment effect as exhibited over the short term applies, and helps expand the productive capacity of the economy, leading to higher labor demand and wages. With the increase in labor income and wealth, consumption flips to become a positive contributor to GDP as is the case with private investment.

75. The reduction in government debt means that there are less domestic assets available to households. So in order to maintain a certain desired level of financial wealth, households would demand more foreign assets, which implies a higher current account is required to accumulate those assets, especially in the short term. Furthermore, the real exchange rate depreciates as more goods are available that need to be sold abroad.

76. These results are stronger when the debt rule is more aggressive, pursuing the five-year horizon to meet the target. The faster convergence to the long-term debt target implies changes in economic flows occur rapidly in the first several years. As noted above, since GST is the adjusting instrument, this further reduces consumption in the short-term and lead to looser monetary policy and stronger private investment. The faster government dissaving leads to a quicker real exchange rate depreciation, with larger current account surpluses on impact.

The Best Aggregated Fiscal Rule for the Transition Regime

77. We assess below which debt rule performs the best under the benchmark scenario and other illustrative downside scenarios. In weighing the effect of risks, we revisit two of our illustrative scenarios from above in order to compare the usefulness of the long-term and medium-term anchors – the unexpected temporary but substantial increase in aggregate demand (Box 3), and the terms-of-trade-driven boom-bust cycle (Box 4).

78. First, consider the temporary but substantial increase in aggregate demand in the context of the benchmark consolidation (Figure 9). Relative to the benchmark scenario, there is more slack in the economy. There is the potential for higher revenues, and automatic social transfers are lower. Prices (including the real exchange rate) face additional upward pressures, requiring a tightening in monetary policy. In terms of the aggregated fiscal rules, the primary role of the increase in aggregate demand is to modify the amount the Government needs to increase the GST to meet its debt rules. The increase in GST also dampens the effect of the shock; it is no longer just the role of monetary policy.

Figure 9.
Figure 9.

The Consolidation under a Temporary but Substantial Increase in Aggregate Demand

(Percent deviation from the No Policy Action Scenario, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations

79. Second, we analyze the impact of the terms-of-trade-driven boom-bust cycle on the benchmark consolidation (Figure 10). Real GDP is much more volatile, and this is reflected in fiscal policy, as the automatic social transfers should be more variable, causing greater interactions with the aggregated fiscal rules, but generally constrained by the ER component. The real exchange rate movements are now dominated by the commodity-driven swings, which is not the case in the benchmark consolidation, leading to an enhanced role for stability from both monetary and fiscal policy.

Figure 10.
Figure 10.

The Consolidation under a Terms-of-Trade-Driven Boom-Bust Cycle

(Percent deviation from the No Policy Action Scenario, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations.

80. Both the ER and the DR are important for achieving the long-term debt anchor. The ER, by definition, always restricts government spending. So, when the economy is expanding it is countercyclical, all else equal, discouraging spending of additional revenues. But when there is an economic contraction, it is procyclical, all else equal, as it may offset the additional spending from automatic social transfers. On the other hand, the DR always works to reduce government debt. So in an expansion, it is countercyclical, absorbing at least some of the fiscal gains, but it is procyclical in a contraction, as it may offset automatic social transfers, just like the ER.

81. We analyze and summarize the outcomes in Table 4. The pace of consolidation ([3] of the criteria in the table) is as expected, since this is a design element of the rules. At least here the rules with the ER and the flexible DR may overshoot – something that would most likely not occur in real-world implementation. The rules with the ER and the strict DR are less flexible ([1] and [2]). They also restrict faster real GDP growth under the alternative scenarios, pushing towards greater countercyclicality [4]. The opposite is true for the rules with flexible DR, becoming more procyclical. Under the benchmark consolidation, such rules are more countercyclical [4], especially under the shorter consolidation horizon of 5 years. Their flexibility also allows automatic social transfers to work, resulting in slightly more real GDP variability [5]. This can be reduced by the faster consolidation rate of 5 years.

Table 4.

Comparing the Performance of the Aggregated Fiscal Rules

article image
Sources: IMF staff estimates and calculations

Communicating the Fiscal Rule

82. Any multi-year fiscal reform package is subject to scrutiny by households and firms. When the Government currently announces a fiscal policy path based only on the medium-term balance anchor, without clear long-term intentions on debt levels and spending, households and firms may not believe the announced path – the path lacks clarity (see Box 5). As a result, economic adjustment by firms and households could be insufficient, implying delayed, and possibly more costly, adjustment. In this sort of environment, which aggregated fiscal rule functions best under a new fiscal regime that is not communicated clearly?

The Concept of Clarity

Four concepts of clarity are illustrated below. These can all be easily implemented in G20MOD.

  1. Fully or immediately clear = Announced reform path is fully stated, so households and firms act upon it immediately and every year following;

  2. Unclear = This year’s reforms are believed and acted upon for only this year; everything returns to its original state starting next year;

  3. Stepwise clear = This year’s reforms are believed as permanent, but the future announced path is ignored; or

  4. Partially clear = This year’s reforms are believed as permanent, and some share of the future announced path is also believed and acted upon – usually contingent on previous years’ actions

The role of clarity in the economy is heavily influenced by the share of LIQ households in the economy. The issue of clarity is irrelevant to LIQ households’ decision process, as they consume only from current disposable income. Their perception of future has no bearing on current decisions, but they are affected by clarity through two other channels. First, firms make decisions that affect labor demand based on clarity. Second, LIQ households have a rule of thumb element in G20MOD, insofar that they take their labor supply decision as given from OLG households.

83. Figure 11 considers the transition to a long-term debt anchor under either an ER with the medium-term balance anchor (a flexible BBR), or an ER and a flexible DR over 10 years. How does this compare to a case where the Government’s intentions are clear from the beginning? In the first year, households and firms believe that after the current year, no further debt reduction takes place (BBR and DR are both abandoned), and government spending growth returns to previous levels (ER abandoned). In the second year, households and firms are proven wrong by continued implementation of the Government’s plans. Once again in the third year, they make the same decision. We assume this continues until the fifth year, when households and firms finally believe the Government will carry out their future announced actions.

Figure 11.
Figure 11.

Achieving a Fiscal Anchor - The Problem of Clarity

(Percent deviation from the No Policy Action Scenario, unless otherwise stated)

Citation: IMF Staff Country Reports 2017, 043; 10.5089/9781475575842.002.A003

Source: IMF staff calculations

84. Unclear communications lead to more negative effects from fiscal consolidation, summarized by real GDP. Once forward-looking households and firms doubt the announced fiscal policy path, they do not account for future consumption and investment decisions. But as the Government enacts its path, the needed adjustment is much larger than it would be otherwise – this is particularly true of the debt rule, as it is more ambitious than the balanced budget rule, despite the flexibility present in both. Conversely, full clarity also allows households and firms to accrue benefits more rapidly, by borrowing against future gains in wealth – that is, they smooth their consumption. Some of the losses can be offset by the central bank, with greater decreases in the overnight cash rate.

Conclusions on the Long-Term Fiscal Strategy

85. The long-term fiscal strategy is better served if it uses an explicit long-term objective, such as a long-term debt anchor based on the government-debt-to-GDP ratio. We have demonstrated that a long-term debt anchor is better than a medium-term balance anchor. It can be achieved by the combination of an expenditure rule and a debt rule. Our subjective ranking on which rule is best on the sustainability of debt and stability of the economy during transition to the long-term debt anchor is as follows.

86. We prefer the flexible DR that aims to return debt to its target after 10 years, even though it is a slower adjustment to the debt norm. This rule is more consistent on procyclicality across our illustrative scenarios and is closer to zero. Debt behavior is more flexible under this rule, as shown by the higher values for RMSD, although this sacrifices somewhat on precision of achieving the target (the higher values for AMD). On the positive side, real GDP is less variable.

87. Our second choice is that of the flexible DR returning debt to its target after 5 years, followed by the strict DR. The differences are not substantial, and either of the flexible DR may be more advantageous than the strict DR as they provide greater certainty, either through a shorter adjustment horizon, or a definitive stance on the debt target in any given year.

88. Using the GST as the adjusting fiscal instrument would require some tactical planning. The Commonwealth and State governments could introduce a portion of the GST that accrued strictly to the Commonwealth government, which the Commonwealth could then use as a policy instrument. In that case, for example, the Government could propose a schedule of implementation of increase in GST in its tax switching. In addition, they could announce a schedule of tax credits that increase as needed later on. Another approach would be to announce tax credits even in the short term, and offset the weakening effects on revenues by broadening the tax base now.

G. Conclusions

89. We do not recommend a strict pursuit of the medium-term balance anchor at this point in time. We acknowledge the usefulness of the Budget 2016-17 commitment to a +1 percent of GDP Commonwealth government surplus. First, there is uncertainty on the required magnitude for budget repair. Second, it relies on rebalancing, shifting to the external sector from the domestic sector which may not be a desirable property. Moreover, the primary risk right now is the “new mediocre,” where budget repair would be very costly.

90. Regardless of the resolution of the short-term situation, for long-term stability, we recommend the use of a fiscal rule for consolidation, based on a long-term debt anchor. Such a rule should increase households’ and firms’ certainty about their wealth holdings and enable clear planning. We do not address the precise value for the anchor, as this should be a choice of the Government. Moreover, choices for short-term fiscal plan also affect how and when to implement the long-term fiscal strategy.

91. For the new long-term strategy, we recommend the flexible debt rule that attempts to achieve its debt norm over 10 years. On average, it best addresses risks and communication issues. In order to provide favorable conditions for the transition, the Government could also switch the composition of taxes, by taxes on the factors of production (the CIT and PIT) and replace it with an equivalent increase in the GST, in tandem with the introduction of the new long-term strategy.

Appendix I. Overview of the Theoretical Structure of G20MOD

G20MOD is an annual, multi-region, general equilibrium model of the global economy combining both micro-founded and reduced-form formulations of various economic sectors. Structurally, each country/regional block is close to identical, but with potentially different key steady-state ratios and behavioral parameters. We discuss, first, the demand side of the economy, with particular emphasis on the inclusion of an overlapping generations model for households and firms; second, the supply side and prices; and, third, the commodity sector and its role as a global stabilizer. We then provide a brief overview of the financial features and monetary policy, concluding with a short description of the fiscal block. The interested reader is referred to Andrle and others (2015) for a more complete description of the model and its properties.

The consumption block uses a discrete-time representation of an OLG model as in Blanchard (1985), Weil (1989) and Yaari (1965). It is based on a constant-elasticity-of-substitution utility function, dependent only on household consumption. Using OLG households rather than infinitely-lived households results in important non-Ricardian properties whereby the path for government debt has significant economic implications. In the OLG framework, households treat government bonds as wealth since there is a chance that the associated tax liabilities will fall due beyond their expected lifetimes. The OLG formulation results in the endogenous determination of national savings given the level of government debt. The global real interest rate adjusts to equilibrate the global supply of and demand for savings. The use of an OLG framework necessitates the tracking of all the stocks and flows associated with wealth - human wealth (based on labor income) and financial wealth (based on government debt, the private business capital stock, and net foreign assets). It should be noted that financial markets are incomplete, so international financial flows are tracked as net positions (net foreign assets or net foreign liabilities) and denominated in U.S. dollars.

Consumption dynamics are driven not only by OLG households, but also by liquidity-constrained (LIQ) households. LIQ households do not have access to financial markets, do not save, and thus consume all their income each period. This feature amplifies the non-Ricardian properties of the basic OLG framework, particularly in the face of temporary fiscal shocks.

Private investment uses an updated version of the Tobin’s Q model, with quadratic real adjustment costs. It is negatively correlated with real interest rates. Investment cumulates to the private capital stock, which is chosen by firms to maximize their profits. The capital-to-GDP ratio is inversely related to the cost of capital, which is a function of depreciation, the real corporate interest rate, the company income tax rate, and relative prices. The corporate interest rate is a mix of the 1-year and 10-year interest rates, with a risk premium negatively correlated with the output gap, to capture a financial accelerator effect as in Bernanke and others (1999).

Government absorption consists of spending on consumption good and infrastructure investment. Both are exogenous choices determined by the government. Government consumption spending only affects the level of aggregate demand. Government investment, in addition to affecting aggregate demand directly, also cumulates into a public capital stock, which can be thought of as public infrastructure (roads, buildings, etc.). A permanent increase in the public capital stock permanently raises the economy-wide level of productivity.

Net exports react to its long-term determinants, the real competitiveness index (RCI), adjusting to achieve the current account balance. In turn, the current account balance is required to support the desired net foreign asset position. Exports and imports, individually, are modeled as reduced-form equations. Exports increase with foreign activity, and are also an increasing function of the depreciation in the RCI. Imports increase with domestic activity, and are an increasing function of the appreciation of the real effective exchange rate (REER). The RCI differs from the REER in that it is export-weighted and accounts for third-country competition effects. In our analysis, when we mention real exchange rate movements, they apply equally to the RCI and the REER at least qualitatively, if not quantitatively.

The model does not track all the bilateral trade flows among countries. This keeps the dimensionality of the model small enough to allow it to have a large number of individual country blocks. The model has been developed to have exchange rate and export volume properties that are similar to the IMF’s multiple-good, structural models. This is accomplished by having time-varying trade shares that are a function of the relative level of tradable and nontradable productivity within each country. Consequently, the model is able reproduce the currency appreciation that results when a country’s tradable sector productivity growth exceeds that in the nontradable sector (the Balassa-Samuelson effect). Further, even though only the aggregate levels of exports and imports are tracked in each country, there are mechanisms in place that ensure global exports and imports sum to zero.

The current account and implied net-foreign-asset positions are intimately linked to the saving decision of households. The model can be used to study both creditor and debtor nations as non-zero current accounts can be a feature of the well-defined steady-state in the OLG framework.

Aggregate supply is captured by potential output. It is based on Cobb-Douglas production technology with trend total factor productivity, the steady-state labor force, the non-accelerating inflation rate of unemployment (NAIRU), and the actual capital stock. This allows for the computation of the output gap, allowing for the tracking of excess demand and excess supply, and is a key driver for prices in the economy.

There is an endogenous labor sector. Steady-state population growth is taken as exogenous, although there are cyclical variations in both the participation rate and the unemployment rate. The behavior of the participation rate is based on properties of labor supply observed in other IMF structural models, the Global Integrated Monetary and Fiscal model (GIMF) and the Global Economy Model (GEM), with both a substitution effect based on the real wage, and an income effect based on the total level of wealth in the economy. The unemployment rate varies relative to the NAIRU in the short term according to an Okun’s law relationship based on the output gap.

The core price is the consumer price index excluding food and energy, CPIX, determined by an inflation Phillips curve. CPIX inflation is sticky and reflects the expected paths of exchange rates and the economic cycle, as captured by the output gap. In addition, although the direct effects of movements in food and energy prices are excluded, there is a possibility that persistent changes in oil prices can leak into core inflation. The degree of forward looking behavior in inflation is country specific.

Relative prices mimic the structure of the national accounts. They are usually some weighted average of a domestic consumer price and an import price. Export prices account for third country effects in its foreign component, and import prices are an import-weighted average of all other countries’ export prices

In addition, there is a Phillips curve for nominal wage growth. Wage inflation exhibits stickiness and allows the real wage to return to its equilibrium only gradually depending on the expected evolution of overall economic activity and the deviation of labor supply from labor demand in the short term.

There are three commodities – oil, food and metals. Australia is an oil importer in this context, but a notable exporter of metals. The demand for commodities is driven by global demand and is relatively price inelastic in the short term due to limited substitutability of the commodity classes considered. The supply of commodities is also price inelastic in the short term. Countries trade in commodities, and households consume food and oil explicitly, allowing for the distinction between headline and core CPI inflation.

Commodities can function as a moderator of business cycle fluctuations in the model. In times of global excess aggregate demand, the upward pressure on commodities prices from sluggish adjustment in commodity supply relative to demand puts some downward pressure on global aggregate demand. Similarly, if there is global excess supply, falling commodities prices softens the effect of deterioration. However, shocks originating in the commodities sectors can be highly disruptive to global macroeconomic activity. Also, when countries’ or regions’ own business cycle is out of sync with the global business cycle, commodity prices act to amplify rather than dampen fluctuations in activity.

In the short term, the nominal side of the economy is linked to the real side through monetary policy. The behavior of monetary authorities is represented by an interest rate reaction function based on a 1-year interest rate, referred to as the overnight cash rate in the case of Australia. The standard form is an inflation-forecast-based rule operating under a flexible exchange rate, as is the case for Australia. Monetary policy can play a key role in fiscal matters, either by working at cross-purposes when the inflation target is being strictly pursued in a time of deliberate fiscal stimulus, or by working in tandem by allowing monetary accommodation at the appropriate times. Under constrained monetary policy space and rising probability of hitting the effective lower bound on interest rates, overly ambitious fiscal consolidation can exacerbate the cost to the economy.

Long-term interest rates affect households’ and firms’ decisions. The model features a 10-year interest rate, based on the expectations theory of the term structure, plus a term premium. The interest rates on consumption, investment, government debt and net foreign assets are weighted averages of the 1-year and 10-year interest rates, reflecting their differing term structures, and allowing for a meaningful role for the term premium.

Fiscal policy is driven by a sufficiently detailed government sector that can reproduce simplified fiscal accounts for each country. Eight policy instruments are featured. On the spending side, in addition to government consumption and spending on infrastructure spending, there are general lumpsum transfers to all households (such as pensions, aged care provisions, unemployment insurance) and lumpsum transfers targeted to LIQ households (such as welfare, certain pensions). On the revenues side, there are taxes on consumption (the goods and services tax, GST), personal income (PIT, on both wage and dividend income) and company income (CIT), as well as taxes and royalties from the mining and production of metals. For Australia, the government is an amalgam of the Commonwealth and State governments. However, many of the issues in this paper focus on the Commonwealth accounts and balances.

Relative to other versions of G20MOD, there is more detail related to the taxation of firm (or ‘company’) income, which applies specifically to Australia. Firms pay CIT, and also issue dividends. Households notionally pay their marginal tax rate on dividend income as part of their payment of PIT (along with taxes on their wage income). In Australia, households are rebated the tax amount already paid by firms as CIT – the dividends are “franked.” This means that if the CIT rate is lowered, the amount of franked dividends that OLG households receive will be reduced, and the dividend income tax portion of their PIT liability will be higher. Therefore, if there is a tax switch from CIT to PIT, not only will the PIT liability on households increase, the burden of the increase will fall on OLG households, as they are solely responsible for the dividend income portion. Only the wage income portion of the PIT increase will be shared with LIQ households.

The budget constraint in the model is met by the choice of a long-term deficit target, relative to GDP. Specifically, the deficit is expenditures and interest payments, less revenues. One instrument, which is general lumpsum transfers by default, is constantly adjusted to make sure that the budget constraint always holds. The long-term government debt target, relative to GDP, can be derived from the government deficit target, based on the nominal growth rate of the economy:

btar=(1+π)(1+g)(1+π)(1+g)1gdeftar

where π is inflation, g is the steady-state growth rate, btar is the long-term debt target, and gdeftar is the long-term deficit target. The explicit deficit target therefore pins down the long-term government debt, a fundamental decision variable for firms and households worldwide. The level of government debt affects the global interest rate (the price used to equilibrate global saving with global investment), and the real exchange rate (a country’s relative price for its contributions and use of the global saving-investment pool). The operational implementation of the deficit target is complemented with the use of fiscal rules, which are explained more fully in the body of the paper.

References

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1

Prepared by Allan Dizioli (RES), Philippe Karam, Dirk Muir and Siegfried Steinlein (all APD).

2

See Appendix I for a succinct description of G20MOD. A complete description can be found in Andrle and others (2015).

Australia: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept
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    Fiscal Balances 1/

    (% of GDP)

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    Debt Dynamics 1/

    (% of GDP)

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    The Cyclically Adjusted Primary Balance and Stability 1/

    General Government

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    Commonwealth Gov’t Deficits

    (% of GDP)

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    Budget Forecasts of Tax Growth

    (% of GDP)

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    The “New Mediocre”

    (Percent deviation from baseline, unless otherwise stated)

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    Budget Repair at a Risky Juncture

    (Percent deviation from baseline, unless otherwise stated)

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    Long-Term Spending Pressures

    (Percent deviation from baseline, unless otherwise stated)

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    Tax Switching

    (Percent deviation from baseline, unless otherwise stated)

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    (Percent deviation from baseline, unless otherwise stated!

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    (Percent deviation from baseline, unless otherwise stated)

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    The Benchmark Consolidation

    (Percent deviation from the No Policy Action Scenario, unless otherwise stated)

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    The Consolidation under a Temporary but Substantial Increase in Aggregate Demand

    (Percent deviation from the No Policy Action Scenario, unless otherwise stated)

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    The Consolidation under a Terms-of-Trade-Driven Boom-Bust Cycle

    (Percent deviation from the No Policy Action Scenario, unless otherwise stated)

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    Achieving a Fiscal Anchor - The Problem of Clarity

    (Percent deviation from the No Policy Action Scenario, unless otherwise stated)