SEMINARIO INTERNACIONAL

La crisis Global de 2008-2010. Respuestas en las Amricas y el Este Asitico.

11 y 12 de julio de 2011. Sala del Consejo Acadmico, UAM-Xochimilco.

Australias Experience with Fiscal Stimulus in Response to the Global

Financial Crisis
Malcolm Bosworth and William Witheridge1
1.

Introduction
Australia was one of the first developed economies to adopt a comprehensive Keynesian-

styled fiscal stimulus in response to the Global Financial Crisis (GFC). This came in two major
rounds of increased government expenditure, in tandem with interest rate cuts by the Reserve
Bank of Australia (RBA), and a government guarantee of all standard retail bank (including
foreign bank subsidiaries) and non-bank (building societies and credit unions) deposits in
Australia. Fiscal policy rapidly replaced monetary policy as the main cyclical weapon as the
official cash interest rate bottomed at 3% from April-October 2009 (currently 4.75%).
Leading into the GFC, the incoming Labor Australian Government fortunately had a
strong budgetary position, with a forecast surplus and zero net public debt. This reflected the
overall strength of the Australian economy and the previous Liberal Coalition Governments
tight budgetary policy. This rapid fiscal stimulus response was, at least temporarily, a significant
departure from the Governments fiscal priorities.
Australias successful experience through the GFC is widely recognized internationally,
such by the IMF and the OECD. The economy survived the GFC far better than other developed
economies, avoiding recession with unemployment rising by less than 1 percentage point.
Fundamental to this was that Australias banking system, unlike elsewhere, remained sound, due
to a relatively stable real estate market. The fiscal stimulus, although a sharp and significant

Respectively, Visiting Economist at ANU Enterprise and economist in the Australian Public Service. Contact
details are Malcolm.Bosworth@anuenterprise.com.au and William.Witheridge@anu.edu.au. The majority of this
paper was written upon the completion of William's studies at the Australian National University, before
commencing employment in the Australian Public Service. The views expressed are those solely of the authors and
do not necessarily reflect those of ANU Enterprise, the Australian Government, or the Australian Public Service.
The authors would like to thank Dr Timo Henckel from the Australian National University for helpful comments.

Calzada del Hueso 1100, Col. Villa Quietud, Delegacin Coyoacn, C.P. 04960, D.F. Mxico.

turnaround, affected the Governments budget far less than the major economies hardest hit by
the GFC, with the Australian deficit peaking at -4.3% of GDP in 2009-10.
Since October 2009, the official cash interest rate has been increased due to the strong
recovery of the Australian economy, and mounting inflationary pressures, with the current
annualized rate of 3.3% slightly above the upper end of the RBAs targeted annual range of 23%. At the same time, fiscal policy remains modestly expansionary (estimated deficit of -3.6%
of GDP in 2010-11) and forecast to return to a small surplus of 0.2% of GDP in 2012-13 (deficit
of -1.5% of GDP in 2011-12), raising possible policy co-ordination concerns. While the
Government is still steadfastly committed to fiscal consolidation, recent natural disasters in
Queensland and Victoria have exerted additional budgetary pressures. Expected budget deficits
in 2010-2011 and 2011-12 as a share of GDP were revised upwards substantially as a result, by
29% and 150%, respectively.
The paper identifies the main transmission mechanisms of the crisis to Australia. When
the crisis hit, Australia was experiencing a mining export boom fed by rising commodity prices
and rapid Chinese growth, fuelling strong mineral demand. The Governments response helped
build the resilience of the Australian banking system during the GFC. Trade was always seen as
the main mechanism by which the GFC would generate a severe domestic downturn. Hence, the
fiscal stimulus was predicated largely on the need to replace falling export demand with
government spending to maintain domestic activity.
The paper discusses the main components of the stimulus packages, highlighting what
worked best. In order to achieve an urgent fiscal response, expenditure priorities included
immediate cash payments to Australians, followed by major infrastructure projects, including a
school building program, increased construction of public and community housing and an
insulation batts installation program for housing, also seen as an environmentally sound
measure.
Debate exists among economists about whether the fiscal stimulus was required or at
least went too far, especially as the mineral boom quickly resumed following Chinas renewed
rapid growth and relatively minor impact the GFC had on its economy. The spending efficiency
of the stimulus infrastructure programs especially has been questioned, with evidence of some
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wasteful or economic inefficient expenditure, as well as Australias future fiscal discipline and
its impact on Australias future economic performance.
2.

Overview of the Australian economy

Australia is the 17th largest economy with annual nominal GDP of approximately USD $1

trillion. It was one of the few advanced economies to escape recession in 2009, reflecting
enhanced links with Asia, especially strong Chinese and Indian demand for commodities, a
prompt and significant macro policy response to the GFC, a healthy banking sector, and a
flexible exchange rate (IMF 2010). Australia also had a strong position at the onset of the GFC,
whereby sound macroeconomic policies and structural reforms had secured years of continuous
growth; unemployment was historically low and inflation subdued (Figures 1 and 2). The
economy grew by 2.3% in 2009-10, and is expected to grow by 2.25% in 2010-11 and 4.00% in
2011-12; unemployment is expected to hover around below 5% (Treasury 2011).
Australias fiscal framework is to contribute to moderating cyclical fluctuations in
economic activity and to maintain prudent Commonwealth Government debt levels.
Services, mainly education, tourism and finance, contribute 80% of GDP. Mining has
grown significantly over the past decade and now accounts for 9% of GDP, while the shares of
manufacturing and agriculture have both continued to decline to 9% and 2%, respectively.
Figure 1: Quarterly GDP, June 2007 to September 2010

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Figure 2: Unemployment rate, July 2007 to December 2010

Australias traditional minerals and farm products account for one-half of total exports.
Mineral exports have been fuelled by rising global demand for commodities, particularly from
China and other Asian economies (Figure 3). North Asian economies, especially China (22%),
Japan (20%), Korea (8%) and India (7%), US (5%) and the UK (5%) were Australias main
export markets in 2009. Service exports have grown substantially, with education now
Australias 2nd largest single foreign earner after coal.

Figure 3: Growth in merchandise exports, September 2007 to September 2010

50
40
30
Per cent

20
10

China
World

0
-10
-20
-30
-40

Source: Reserve Bank of Australia

4|Page

Japan
USA

3.

The Global Financial Crisis and Australia

The GFC, which started in the US and Europe from early 2008 and accelerated until

September 2008 when Lehman Brothers Bank failed, began impacting in earnest in Australia in
December 2008 when GDP growth fell to just over 1%. It continued until the September 2009
quarter, when growth had improved slightly to 0.9%, after bottoming in the previous quarter at
0.8%.
The GFC raised unemployment by only 1.4 percentage points, which has returned close
to structural levels and currently exceeds pre-crisis levels by only 1 percentage point (OECD
2010). However, since this seemingly partly reflects rising part-time relative to full-time
employment in 2008-09, the unemployment rate may underestimate the GFCs impact on jobs.
Unemployment was forecast to peak at 8.5% with the stimulus, expected to create an estimated
210,000 new jobs thereby reducing unemployment by 1.5% (Treasury 2009). However, these
projections proved questionable as unemployment peaked at much lower levels of 5.8%.
International trade was seen as the main mechanism for transmitting the GFC to the
Australian economy. It was feared the GFC would ravage Australias major markets, especially
China, depressing global demand and export oriented industries, thus reducing domestic demand
and causing severe economic recession that would badly affect employment and growth.
While Australian merchandise exports fell in the first three quarters of 2009, especially in
the June quarter by 18%, these lagged the onset of the GFC effects on growth. Export expansion
resumed slightly in the December 2009 quarter and accelerated in the June 2010 quarter of 25%.
Thus, exports to major markets held up reasonably well, helped mainly by commodities and
China, Australias main market, which fell modestly in only the September 2009 and March
2010 quarters by -8% and -1%, respectively (Figure 3). Annually, the decline of 12% in
Australian merchandise exports in 2009 followed a startling 32% rise in 2008; in 2010 they
jumped again by 17%. Exports in 2009 nominally exceeded 2007 levels by 16%.
Australias export markets have changed dramatically from advanced economies to fastgrowing emerging Asian countries. In the past 20 years, exports to China and India grew by
almost 20% annually (in US$ terms) compared with 3% for the US and Germany. Asian growth
and associated mineral demand has underpinned the Australian economys resilience, pushing
5|Page

the terms of trade to record highs (IMF 2010, Gruen 2011). Australias low reliance on industrial
exports also reduced the GFCs effects on the economy.
While many businesses quickly responded to the GFC by slashing production and
reducing inventories, falling sharply in real terms by $3.4 billion in the December quarter 2008,
Australia avoided negative growth and recession. The contribution of the GFC to Australias
slowed growth on a cyclical basis is uncertain since growth had started to fall substantially since
peaking in the September 2007 quarter at almost 5%, suggesting that other factors, perhaps more
structurally based, have been emerging. This may cast some doubts on the ability of Australia to
return to high sustainable economic growth without re-invigorating productivity-enhancing
reforms.
4.

Key Features of Australias Stimulus Packages

To insulate the Australian economy from the GFC, policymakers responded quickly with

monetary and fiscal policy measures. Evidence suggests the stimulus measures improved
consumer confidence, which rose sharply after the second package was announced.
4.1 Fiscal policy
Faced with falling domestic consumption and export demand, two stimulus spending
packages were implemented in October 2008 and February 2009, respectively (Tables 1 and 2).
Expansionary fiscal policy sharply contrasted with budget surpluses of the previous Government,
which left office in November 2007. Stimulus was mainly delivered through cash payments and
infrastructure spending.
The first stimulus package focused on stimulating consumption via cash payments
directed to those with a high propensity to consume. The housing industry was also supported
through first home buyer grants aimed at accelerating construction to meet the strong demand at
lower interest rates. Also, in December 2008, the Government brought forward scheduled largescale infrastructure projects worth $4.7 billion.

6|Page

Table 1:First Stimulus Package, 14 October 2008

Measures
Amount (A$
billion)
Cash payments to low and middle-income families and
8.7
pensioners
Increased first home buyers grant
1.5
Additional training places
0.187
Total
10.4 (1% of GDP)
The much larger second stimulus package focused spending on longer term infrastructure
investment. Also in early 2009, the Government announced a $1.5 billion package to guarantee
technical training to unemployed less than 25 years of age. The 2009-10 Budget also accelerated
additional spending of $22 billion.
Table 2: Second Stimulus Package, 2 February 2009
Amount (A$
billion)
One-off cash payment ($950) to working Australians,
12.7
families with school-age children, farmers, and those
undergoing training
School buildings program
14.7
Public, community and defense housing
6.6
Energy efficiency measures; home insulation and solar
3.9
rebates
Road and rail infrastructure
0.89
Business equipment investment tax break
2.7
Total
41.49 (4% of GDP)
Measures

The Governments strong budgetary position leading into the GFC (surplus in 2007-08 of
$14.4 billion or 1.3% of GDP) facilitated this rapid and significant, although measured fiscal
stimulus. The Budget deficit of $27 billion (2.2% of GDP) in 2008-09 peaked at -4.3% of GDP
in 2009-10. It is projected to fall to 3.6% of GDP in 2010-11, and to return to a small surplus of
0.2% of GDP in 2012-13. Australia is projected to have the lowest net debt as a share of GDP
among advanced economies, peaking at 6.4% in 201112 (Source: Treasury 2010).
This discretionary expenditure was additional to the effects of automatic stabilizers on the
budget, which tend to increase the deficit as economic activity contracts. However, Australias
automatic fiscal stabilizers are modest relative to some other OECD economies (OECD 2010).

7|Page

Against this, however, Australias stimulus was measured compared with overseas. The
fiscal deficit peaked at only 4.3% of GDP in 2009-10, and was much lower in other years.
Figure 4: Budget balance, 2004-05 to 2013-14

4.2

Monetary policy

In line with sound principles of macro-economic stabilization, monetary policy was the main
anti-cyclical weapon, especially in the beginning.
Bank Guarantee
The Government, supported by the RBA, introduced the 3-year Bank Guarantee Scheme
in October 2008. This guaranteed retail bank deposits (including foreign bank subsidiaries) and
deposits of certain non-bank institutions (credit unions and building societies) of up to $1 million
and, for a fee, Australian bank wholesale borrowings to fund operations. The Scheme was aimed
at promoting stability and confidence in the financial system, and assisting institutions in
continuing to access funding during turbulent times. This was also seen as necessary to ensure
Australian financial institutions were not competitively disadvantaged by similar government
guarantees implemented by some other countries (e.g. US and UK) in response to the GFC.

8|Page

The Scheme generated significant funds to institutions eligible for the guarantee. With
improved funding conditions and global market stability, the Scheme was closed to new
liabilities from end-March 2010; existing deposits remain guaranteed.
Financial System
The resilience of the Australian financial system was helped by Australian banks lending
mainly domestically and having minimal direct exposure to overseas toxic assets. The GFC
did, however, affect Australian banks by decreasing global liquidity and raising borrowing costs,
causing fears that the housing market and construction industry would suffer. The residential
housing market and prices, however, remained resilient, and loan defaults rose slightly. A
consensus as to why Australian banks remained secure was that the housing bubble did not burst;
the high property prices reflected the relative scarcity of new land released by state governments
in capital cities. Nevertheless, the RBA is still concerned by the housing bubble, based on the
(historical) correlation between high house prices bubbles and strong private credit growth
during the past decade.
Australias four major banks retained their high credit ratings during the crisis, and were
among only ten globally to maintain a minimum Standard & Poors AA rating. Consolidation of
the Australian financial industry also occurred as the Big Four retail banks absorbed several
lending institutions.2
Interest rates
The RBA, having raised interest rates to dampen an emerging property bubble, responded
aggressively to the GFC by cutting official levels by a total of 4.25 percentage points from
September 2008 to April 2009 (Figure 5). This mortgage relief encouraged consumer spending.
Banks and other lending institutions faced with higher global costs of capital maintained
profitability by not reducing interest rates by the full amount of the official cuts. Nevertheless,

Australias four pillar banking policy prohibits mergers among any of the top four domestically-owned banks.
Views differ as to whether this policy is anti-competitive and limits the rationalization of the banking system and
growth of larger internationally competitive Australian banks. Most recently, a top four bank acquired the fifth
largest bank after being cleared of anti-competitive concerns by the Australian Consumer and Competition
Commission (ACCC).

9|Page

the transmission of monetary policy tightening via official interest rate cuts was very effective as
they were largely reflected in mortgage and business lending rates (IMF 2010).
Figure 5: Official interest rates, June 2007 to February 2011

The RBA injected liquidity into the credit and foreign exchange markets by directly
trading Australian dollars using currency reserves, and introducing a term deposit auction
facility. It did not resort to quantitative easing, unlike the USA, UK and the Eurozone. Australian
official interest rates bottomed well above zero, thus leaving plenty of scope to further tighten
monetary policy. However, authorities saw this unnecessary given the economys rebound and
the complementary moderate fiscal stimulus.
Exchange Rates
Most importantly, the exchange rate behaved as a crucial non-fiscal automatic
stabilizer. The Australian dollar depreciated by about 18% in the December quarter 2008 and a
further 6% in the March Quarter 2009 (trade-weighted index), due mainly to falling global
demand and prices for commodities, fuelled by rising uncertainty. Depreciation was also
accentuated by declining interest rates which reduced foreign inflows. This lowered relative
prices of Australian exports, thus boosting export receipts and GDP growth above what they
would otherwise be as a result of the GFC.

10 | P a g e

During these two quarters, the depreciation of the A$ was particularly large against the
Yen, Yuan and US$. It was quickly reversed from June 2009 as the commodity boom resumed
and global commodity demand and prices rebounded strongly mainly on the back of Chinas
strong and largely uninterrupted growth. Rising interest rates and associated increased capital
inflows also boosted the A$.
The sharp depreciation of the A$ during late 2008 and early 2009 played a pivotal role as
a key shock absorber in insulating Australian national output and employment from the worst
effects of the GFC, something that has been badly overlooked (Makin 2010).
Figure 6: A$ exchange rate movements, September 2007 to December 2010
20
15
10
5
dic-2010

sep-2010

jun-2010

mar-2010

dic-2009

sep-2009

jun-2009

mar-2009

dic-2008

sep-2008

jun-2008

-15

mar-2008

-10

dic-2007

-5

sep-2007

Per cent

-20
-25
-30
TWI

-35

Yen

US$

Euro

Yuan

Source: Reserve Bank of Australia

6.

Assessing Australias Fiscal Stimulus

It is generally regarded that a successful fiscal stimulus must be timely, targeted and

temporary (Elemendorf and Furman 2008). An ideal fiscal stimulus policy response would be
sufficiently timely to stimulate economic activity precisely as the economy contracts; a poorly
timed fiscal stimulus can exacerbate instability and business cycles. The stimulus should target
measures providing the greatest boost to short-run GDP and activities hardest hit by the
economic downturn. Finally, the stimulus should be temporary and not permanently affect fiscal
discipline. Long-term expansionary fiscal policy measures are likely to counteract monetary
policy as economic conditions rebound. Any fiscal stimulus should adequately balance these
11 | P a g e

principles and any associated trade-offs. Given uncertainties when formulating policy,
governments should be flexible in the longer term to ensure the stimulus is contingent on future
economic performance.
Generally speaking, the Australian fiscal stimulus performed satisfactorily when assessed
against these key principles. The Government responded pro-actively to the GFC by immediately
injecting one-off cash payments (equivalent to almost 1% of GDP) to low income families and
pensioners through the welfare system. These groups, generally with relatively high marginal
propensities to consume, had the potential to support retailing, a sector likely to suffer from
reduced spending from the GFC. Cash payments boost discretionary income and help maintain
spending levels, equivalent to an immediate one-off income tax cut.
As the GFC worsened, the Governments second and significantly larger stimulus
package was implemented in early 2009. It also provided immediate one-off cash payments, this
time to almost all taxpayers, and an expenditure program based on industry specific programs,
infrastructure and capital works spread over two years. The package aimed to directly support
economic activity with public demand and provide jobs in the construction and domestic retail
industries.
Thus, the fiscal stimulus was particularly timely and targeted. The economys resilience
was aided by a prompt monetary policy response, and a large, timely and targeted fiscal stimulus
(OECD 2010). Some doubts persist as to its temporariness, although exit strategies are in place
with the deficit declining substantially. While many of the measures used were one-off cash
payments and infrastructure programs, the fiscal deficit is forecast to continue until 2012-13 due
mainly to the fall in tax receipts. Assuming this objective is met the budget will have been in
deficit for four years. As the economy recovers, it is prudent that the government return the
budget also to a strong position.
6.1

Spending efficiency
While the Australian fiscal stimulus broadly rates high on these principles, some

programs suffered on spending efficiency. Based on Australias experience, a fourth key

principle for assessing fiscal stimulus should be added, namely efficiency. Policymakers should
ensure that measures are well structured to provide the correct economic incentives, and

12 | P a g e

sufficiently monitored and regulated to be efficiently implemented. Some areas of Australias

stimulus package underperformed on this basis.
The Government has defended some policies as being the inevitable cost associated with
having to respond quickly to the GFC with a stimulus program to support the economy and
employment. While in implementing fiscal stimulus in response to a severe global downturn,
governments must in general trade off efficiency and timeliness of spending measures, they
should ensure that the expenditure programs are implemented efficiently to minimize waste.
Some of the expenditure programs were also designed to achieve other policy objectives,
such as environmental outcomes, by an incoming Labor Government that was keen to meet some
of its electoral commitments. Due to the time constraints in formulating stimulus program
measures, detailed evaluation of the programs efficiency or economic consequences were not
undertaken. Consequently, the schemes were poorly designed and/or administered, leading to
some inefficiency in achieving their objectives, even if the goals were considered appropriate.
Australias stimulus program demonstrates how sound design and implementation
practices are required to achieve desirable policy outcomes.

The programs did seemingly

stimulate the economy, but at a cost to public spending efficiency. Ensuring that programs have
proper incentives for intended outcomes, and careful oversight to prevent cost-blowouts or
unintended economic outcomes is a vital lesson for future policy responses.
School buildings program
The single largest component of the Governments stimulus package was the Building the
Education Revolution (BER) Program. It aimed at investing $14.7 billion in new and refurbished
school buildings by March 2011 quickly stimulate construction and to boost education outcomes.
Over 10,500 projects in nearly 8,000 schools were funded with the majority of work completed;
all projects commenced by the end of 2010.
The BER is believed to have contributed materially to economic growth, especially in the
first year. It supported an estimated 120,000 jobs, and helped reverse the decline in nonresidential construction following the GFC (Auditor General 2010). However, the cost of
providing the quick stimulus was some inefficient expenditure. Less than 3 per cent of the total
13 | P a g e

projects were the subject of complaints to the Governments BER Implementation Taskforce. A
majority of these raised valid concerns, particularly about value for money and the approach to
school level involvement in decision making.
State education departments administered the building contracts with varying efficiency.
For instance, projects in New South Wales Government schools had accounted for 56% of total
nationwide complaints and had the highest total cost per floor area of all states and school types
(BER Implementation Taskforce 2010). Across all other states and school types, the project cost
per floor area was broadly the same. The BER Implementation Taskforces Interim report
concluded that shortcomings have been pronounced in the NSW Government system which
adopted a higher cost, one size fits all, approach in its use of managing organisations and in
product delivered. This emphasizes the importance of the implementation and administration of
such a large and urgent expenditure program to ensure efficiency.
In contrast to public perception of significant waste, the BER Implementation Taskforce
found that the vast majority of projects to be successfully and competently delivered ; a
number were found not to be value for money. It concluded an inverse relationship existed
between work expediency and value for money, and that the need for haste had to be balanced
with the goal of delivering quality, sustainable and value for money school infrastructure
(Auditor General 2010). The Taskforce speculated that delivering the Program within the short
stimulus timeframe may have added a 56% cost premium. While, if correct, this seems a low
additional cost, on a total expenditure program of $14.7 billion this would amount to additional
costs of $730-880 million.
It is hardly surprising that the system lead to higher building costs, as the government
subsidy was shared between the contractors and the Departments paying for the buildings. This
is consistent with basic micro-economic principles, whereby the extent to which building costs
rose would depend on the relative supply and demand elasticities. There is also the contentious
question as to whether providing school buildings were the best means of improving education
infrastructure, or whether other types of expenditure may have been more justified in
contributing to the Governments education goals. Thus, the school building program may have
spent scarce education funds to meet fiscal stimulus objectives by mis-directing spending into
school buildings when other education expenditure was preferable.
14 | P a g e

Home Insulation Program

This Scheme gave owners incentives to install roof heating insulation batts in their home
or business premises, costing $2.8 billion over 2.5 years. This quickly formulated program also
had multiple goals, namely as a stimulus measure to support lower skilled jobs in the housing
and construction industry, and to improve the energy efficiency of Australian premises for
environmental reasons.
Over 1 million premises were insulated, costing $1.55 billion (Auditor General 2010) and
generating an estimated 6000-10000 jobs. However, due to inefficiencies as well as safety and
fire concerns, the Program was terminated prematurely within a year in February 2010. Postaudit inspections found some 30% of premises insulated had serious deficiencies, ranging from
quality issues, safety and fire concerns. Some 4000 potential cases of fraud were identified.
While the value of expenditure on substandard work is unknown, the estimated additional cost of
safety inspections and remediation measures for all premises insulated under the program was
$425 million. The poorly designed Program therefore also failed to meet its environmental
objectives.
Like the school building program, the economic benefits of the subsidy were shared
between the contractors and the property owner. Installation costs rose due to the higher
subsidized demand. Again, to the extent that the Scheme was wasteful, such costs escalated, and
contractors appropriated more of the subsidy. Indeed, by poorly designing the program to
directly pay the installer the rebate instead of the householder to facilitate more claims and faster
payment, increased inefficiency and fraud. While such payment may have been consistent with
the stimulus objective, owners had little incentive to ensure work quality, value for money or
public spending efficiency. At the Programs peak, demand exceeded expectations by 250%,
requiring future budgeted expenditure to be brought forward. The Auditor General concluded
that it was poorly administered by the Federal Department of the Environment, Water, Heritage
and the Arts and the Department of Climate Change and Energy Efficiency, which lacked the
resources and were overwhelmed by the volume of claims (Auditor General 2010).
Due to the tight insulation market emerging from the Program, a new suppliers rushed
into the industry, rising from around 200 registered firms to almost 11,000. Many had no
15 | P a g e

experience, qualifications or insulation training. While the rapid roll out, wide access by both
property owners and installation suppliers and the ease of transactions which drove design and
implementation met the key economic stimulus objective, it was unreasonable to conclude that
such a large program operating within a largely unregulated industry could ever be delivered
without risk (Hawke 2010).
7.

The Australian Experience

7.1

Exiting the fiscal expansion

The Government, backed by the RBA, believes that the fiscal stimulus was successful,

and helped insulate the economy from GFC contagion. This is supported by international
institutions (OECD 2010):
Years of sound policies left ample room for monetary and fiscal policy to act rapidly and
forcefully when the crisis struck. A key to the good outcome was the interaction of
appropriate macroeconomic policy with structural flexibility of markets, especially
financial and labour markets. The strong policy response and encouraging outlook
restored confidence rapidly, and exit from the stimulus is underway.
However, as the OECD and IMF have recently commented, given the rapid rebound of the
Australian economy and emerging supply constraints, especially a tight labour market and
infrastructure bottlenecks, Australia should continue efforts started in 2010 to exit the fiscal
stimulus relatively quickly (OECD 2010, IMF 2010). Australias pre-announced exit strategy
included a multi-year plan to allow tax receipts to rise through fiscal drag during the recovery,
while keeping the tax-to-GDP ratio below the 2007/08 level of 23.6% on average, and restricting
real increases in public spending to below 2% annually until a fiscal surplus of at least 1% of
GDP is achieved, expected perhaps in 2015-16 (IMF 2010, OECD 2010).
Recent weather events have, however, placed additional stress on the Budget. Despite the
Governments repeated assurances, concerns exist that the cyclone damage in Queensland and
flooding as well in Victoria will threaten the proposed fiscal surplus by 2012-13. The recent
2011-12 Budget revised substantially upwards the expected budget deficits for 2010-11 from 2.8% of GDP to -3.6% and from -0.6% to -1.5% in 2011-12, but stuck to a return to a small
budget surplus of 0.2% in 2012-13. The Government has estimated that the Queensland floods
alone will require public investment of $5.6 billion, mostly in repairing and re-building
16 | P a g e

infrastructure. Two-thirds is to be met by spending cuts, including to other infrastructure

projects, and the rest through a one-off progressive flood levy of either 0.5% or 1% on income.
7.2

Coordinating fiscal and monetary policies to tackle inflation

Faced with a rapidly recovering economy underpinned by strong terms of trade and re-

emerging inflationary pressures as supply constraints tightened, the RBA began withdrawing its
monetary stimulus in late 2009 by raising the official policy interest rate to 4.5% in six steps.
These increases flowed through effectively to both mortgage and business lending rates which
have returned close to their 10-year average (IMF 2010). Confronted with global uncertainty and
subdued inflationary pressures since, official interest rates have remained on hold since May
2010. While iecent inflation rates were well within the RBAs targeted annual inflation rate of 23%, the current annualized rate of 3.3% has crept slightly above this range (Figure 7). If so,
monetary policy may need further tightening to contain inflation generated by the mining boom
and supply constraints (IMF 2010).
Figure 7: Inflation rates, September 2007 to December 2010
1.6
1.4
1.2

Per cent

1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4

Source: Reserve Bank of Australia

Since fiscal policy remains expansionary (estimated deficit at -3.6% of GDP in 2010-11
and deficit of -1.5% of GDP in 2011-12) and the RBA has until recently increased interest rates
from emergency levels, with more significant rises expected before the budget returns to surplus,
possible policy co-ordination concerns arise. It has been suggested that the fiscal deficit has
17 | P a g e

already added to higher interest rates (The Australian 2011). This implies that the economic
stimulatory effect of the deficit has been at least partially offset by the contraction induced by
higher interest rates. The debt-financed fiscal deficits also risk crowding out the private sector
and burdening future generations by driving up the cost of funds. However, if budget surplus is
returned in 2012-13 as forecast, these effects are likely to be relatively minor and temporary.
7.3

Exchange rate impacts

Just as the depreciating A$ eased the GFC effects on the Australian economy by

increasing export competitiveness and foreign home currency earnings, so has the recent
appreciation helped stabilize the economy by reducing home currency export receipts, thereby
cooling the emerging heated economy. The sharply rising Australian dollar in nominal terms
since early 2009 has pushed the real exchange rate to record highs, some 35% above its average
level since floated in December 1983 (Figure 6). The higher exchange rate is also being helped
by Australias relatively high interest rates, especially in real terms, and associated inflows.
Thus, to the extent that the fiscal deficit is contributing to higher interest rates, it may also be
maintaining a higher $A with associated deflationary effects.
The high real exchange rate is profoundly affecting the structure of the traded sector of
the Australian economy. In particular, those parts not linked to the production boom in mining
and energy commodities face severe and sustained competitive pressure from foreign
competitors, which is likely to be sustained for the next fifteen years (Gruen 2011). Thus, such
Dutch Disease effects of the boom will continue driving factors of production (labour and
capital) out of non-resource segments (including many, but not all, parts of manufacturing) into
mining and construction. The strongly rising share of employment in mining and construction
has occurred since 2003-04 while the associated decline in the manufacturing share has been ongoing for decades (Gruen 2011).
Much of the economys resilience and macro-economic stability has to do with exchange
rate flexibility. This helped reduce the GFC-induced recession in Australia and is tempering the
inflationary impacts of the subsequent mining boom and associated strong recovery. Indeed, in
an open economy with a floating exchange rate, like Australia, discretionary fiscal stimulus is
likely to be less effective than monetary stimulus (Makin 2010). This is essentially because
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counter-cyclical monetary policy will generate supportive exchange rate movements, unlike for
fiscal policy where the two will work against each other. This is the general conclusion of the
(dominant) Mundell-Fleming model (with some special assumptions). The conclusion may be
different if a country is in a liquidity trap and/or if fiscal policy is coordinated with other
countries.
7.4

Vital importance of structural reforms

While the discretionary fiscal stimulus has helped shelter Australia from the contagion

effects of the GFC, its role has been relatively minor. The greatest contributor was the high
degree of trade openness achieved since the 1980s, including floating of the $A. This produced a
very flexible and resilient economy whereby world price signals are efficiently transmitted
throughout the economy to enable production patterns to respond to changing international
conditions. This has seen major structural changes in the economy, leading to enhanced
resource-use efficiency, major productivity improvements, and changing trade patterns, both in
composition and markets. Australias successful resilience to the GFC largely mirrored the
relatively minor economic impact the Asian Financial Crisis of the late 1990s had on Australia
for similar reasons.
However, a major challenge facing Australia is that the golden era of Australian
unilateral trade and other micro-economic reforms that contributed so much to productivity
growth during the 1990s ended in the early 2000s (Banks 2010, Garnaut 2010). This has caused
productivity growth to slow substantially, even turning negatively according to the broadest
measure over the past five years; this sharply falling performance has been obscured by the
substantial income gains generated by Australias rising terms of trade from the commodities
boom, something that cannot be relied on forever (Eslake and Walsh 2011).
8.

Policy Implications
The GFC caused economists to re-think the role of countercyclical discretionary fiscal

policy, which had been generally rebuked in the early 1990s for not contributing sufficiently to
economic stability (Taylor 2008). Australias experience suggests that while fiscal stimulus can
effectively support economic activity, governments should be wary about the incentive structure
of programs and spending efficiency. There are potential negative economic effects of spending
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deadweight efficiency losses. Monetary policy should remain the main macro-economic weapon
against recessions, and evidence that it has become ineffective and must be supplemented by
discretionary fiscal actions is weak, even in cases where, unlike Australia, official interest rates
reached zero (Taylor 2008). While some economists would disagree, and the threat of worldwide
serious recession led governments to introduce a coordinated fiscal response, some of those
major economies undertaking the greatest fiscal stimulus and economic bailouts have been the
among the slowest to recover. This is particular the case of the Mediterranean Euro-Zone
countries that are suffering unsustainable public debt and individually have no exchange rate tool
to re-establish international competitiveness.
8.1

Cash payments are appealing

The Australian experience suggests that cash payments are likely to be best measures of

delivering fiscal stimulus. These effective immediate income tax cuts seemed to boost private
spending. They had the advantages of timeliness and temporariness, and safeguarded against
inefficient public spending by leaving it to the recipient to decide best how to spend it. The first
cash payment targeted low income earners, including pensioners, while the second payment
covered virtually all Australians. A strict Keynesian framework suggests that targeting poor
consumers with high marginal propensities to consume may provide a bigger countercyclical
stimulus by boosting consumption, however, this is difficult to establish in practice.
At least two qualifications are required. First, while better off consumers may actually
spend a lower share of the cash payment than poorer consumers, the former may nevertheless use
the cash payment as a means of maintaining consumption levels. Second, the unspent or saved
share of the cash payment may provide a stimulus by placing funds in the banking system and
raising liquidity, thus increasing investment demand. Moreover, it is far from clear that using
fiscal stimulus to change the distribution of income towards lower income earners necessarily is
more equitable or a sound economic outcome, which if not may have to be reversed later at
considerable policy effort.
8.2

Infrastructure stimulus programs risky

The Governments infrastructure spending on housing, including school buildings, and

home installation programs were the main sources of waste associated with the fiscal stimulus,
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and probably represented poor public policy sacrificed in the name of stimulus delivery.
Governments should carefully resort to infrastructure spending to deliver a fiscal stimulus. While
appealing, governments rarely have well designed and rigorously analysed programs capable of
quick implementation. Thus, there is a real risk that infrastructure programs will be quickly
cobbled together without appropriate design and cost-benefit assessments.
Aligning the fiscal stimulus to meeting other government objectives, such as
environmental considerations from subsidizing the installation of pink batts, also has similar high
risks of waste and inappropriate public policy outcomes.
8.3

Tax cuts
Australia did not use tax cuts to deliver fiscal stimulus, although the cash payments had a

similar impact. A possible measure that could have been considered would be immediate
temporary cuts in the consumption tax (called the goods and services tax) rate of 10%. This
would have immediately raised spending and consumption as consumers benefited from both a
substitution effect (between consumption and savings) and an income effect. Such a cut would
leave consumers to efficiently spend the money, and could be quickly reversed.
Since the goods and services tax is imposed and collected by the Commonwealth
Government and distributed to State Governments as grants under federalism arrangements, the
Commonwealth Government would have to reach temporary agreement with the States to ensure
that grants were adjusted accordingly to be revenue neutral. This should have been
surmountable. Of course, reductions in the rate would also apply to imports so as to ensure no
increase in protection.
9.

Conclusions
Australias fiscal stimulus in response to the GFC successfully aided economic recovery.

However, on closer inspection it had weaknesses, in particular deadweight efficiency losses and
poor public policy measures associated with government spending. With hindsight, some policy
stimulus measures could certainly have been done differently, and it is a moot point whether
these deficiencies were sufficiently justified on the grounds of needing to deliver a quick fiscal
stimulus. The Australian experience also confirms that monetary policy should be the main
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countercyclical weapon, especially given Australias floating exchange rate, and that these two
instruments have been very important in offsetting the GFC effects and the subsequent mining
boom. Again, whether Australia should have continued to use monetary policy to a greater extent
and/or for longer rather than resorting to the measured fiscal stimulus is difficult to determine.
Irrespective of this debate, the Australian experience highlights above all else the critical
importance of maintaining an open, well regulated and flexible economy that reduces external
vulnerability and builds economic resilience. In this sense, Australias success at stemming the
GFCs contagion fundamentally goes back to the wide-ranging structural, including trade,
reforms introduced since the 1980s to boost productivity. The real future challenge for Australia
is to move on from the fiscal stimulus and to restore the lost reform momentum so as to arrest the
recent sharp decline in productivity growth. If this is not done, then Australia may be less
successful at preventing the spread of the next economic crisis, and will follow a lower growth
path especially as the commodity boom inevitably recedes.
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