Like what you've read?

On Line Opinion is the only Australian site where you get all sides of the story. We don't
charge, but we need your support. Here�s how you can help.

  • Advertise

    We have a monthly audience of 70,000 and advertising packages from $200 a month.

  • Volunteer

    We always need commissioning editors and sub-editors.

  • Contribute

    Got something to say? Submit an essay.

 The National Forum   Donate   Your Account   On Line Opinion   Forum   Blogs   Polling   About   
On Line Opinion logo ON LINE OPINION - Australia's e-journal of social and political debate


On Line Opinion is a not-for-profit publication and relies on the generosity of its sponsors, editors and contributors. If you would like to help, contact us.


RSS 2.0

Fiscal stimulus: handouts v cuts

By Saul Eslake - posted Tuesday, 3 March 2009

I should emphasise at the outset that the views I express here should not be interpreted as being those of my employer or any of its executives.

In the last few months it has become increasingly apparent that, notwithstanding its resilience during the first year of the global financial crisis, the Australian economy faces a much bleaker outlook in 2009. The sharp downturn in the world economy - including in particular China and other Asian economies - in the second half of last year, and the grim outlook for the major advanced economies in 2009 has greatly increased the risk that Australia, too, will experience a recession this year.

The current downturn in the global economy has a number of features unusual in the post-war era - in particular, the role played in inducing it by the large and protracted decline in asset prices (leading to a sharp increase in households’ propensity to save), the impaired condition of much of the world’s banking system (severely interrupting the normal process of intermediation between borrowers and lenders), and the risk of deflation (a persistent and widespread fall in consumer prices).


These features make it less likely that the current downturn can be ameliorated, and an eventual recovery induced, by conventional monetary policy responses; chiefly, lower interest rates.

Reductions in official interest rates have not been fully passed on to borrowers (although this has been less of an issue in Australia than in other countries); borrowers have been, and will be, less inclined to respond to lower interest rates by borrowing and spending more as they might ordinarily do: banks and other lenders have become more cautious about lending, even at lower interest rates; and households and businesses are more inclined to save the cash flow benefit of lower interest rates that do reach them.

Of necessity, therefore, fiscal policy must play a larger role in dealing with the current economic downturn than the conventional wisdom of the last few decades has generally allowed. The advice of international organisations such as the Organisation for Economic Co-operation and Developement (OECD) and International Monetary Fund (IMF), which have hitherto traditionally been opponents of active fiscal policy, has recently been quite unambiguous in this regard.

The distinctive features of the current downturn also shape the form which the fiscal policy response should take. In the environment now prevailing - and likely to prevail for some time - income tax cuts are, as with lower interest rates, likely to be saved especially by those (upper income earners) who typically derive the greatest benefit from tax cuts.

Although there is a strand in the academic economics literature which asserts that people are more likely to spend out of tax cuts which they believe to be permanent, there is no compelling reason to believe that people will regard any tax cuts offered in the present environment (of deteriorating budget deficits) as being permanent - no matter how they are described (and in the Australian context at least some precedents for disbelieving any such assertions).

Hence the most effective fiscal policy response in the current unusual circumstances is likely to take the form of increased government spending. Ideally, as has been emphasised by others, any such increases in government spending should be “timely” - that is, having their impact at the point when the economy is most vulnerable. They should also be “targeted” - that is, designed so as to derive the greatest amount of benefit in terms of supporting activity and employment for the amount spent; as well as “temporary” - so as not to be still providing stimulus any longer than required.


The measures proposed by the government at the beginning of February amount to about 3.5 per cent of one year’s GDP (albeit spread out over a number of years), and are thus broadly commensurate with those envisaged, on average, in other countries (as summarised in The Economist, January 31, 2009).

The government’s proposals broadly meet the “timely” criterion. Their impact is likely to be felt in the quarter in which the money is initially disbursed, and in the following one or two quarters. Unlike fiscal policy measures undertaken during previous downturns, they have been calibrated to be “pre-emptive” rather than “reactive”.

The government’s proposals are also, by deliberate construction, “temporary”. There are no permanent subtractions from revenues or additions to expenditures, other than the interest associated with the borrowings required to finance the deficits resulting from these measures and the “parameter variations”, to estimates of revenues reported in the Updated Economic and Fiscal Outlook.

  1. Pages:
  2. Page 1
  3. 2
  4. All

Discuss in our Forums

See what other readers are saying about this article!

Click here to read & post comments.

9 posts so far.

Share this:
reddit this reddit thisbookmark with Del.icio.usdigg thisseed newsvineSeed NewsvineStumbleUpon StumbleUponsubmit to propellerkwoff it

About the Author

Saul Eslake is a Vice-Chancellor’s Fellow at the University of Tasmania.

Other articles by this Author

All articles by Saul Eslake

Creative Commons LicenseThis work is licensed under a Creative Commons License.

Photo of Saul Eslake
Article Tools
Comment 9 comments
Print Printable version
Subscribe Subscribe
Email Email a friend

About Us Search Discuss Feedback Legals Privacy