How the government can affect the economy

Governments try and stabilize the economy by maintaining good growth, high levels of employment, and balanced inflation. This can be done through fiscal and monetary policy to influence the prices of goods and employment. The state of the economy has a direct impact on the stock market as it would affect the ability of companies in generating profits. Expansionary policies can lead to increased demand and employment. This in turn can lead to more spending which then increases earnings for corporations. Recessions are obviously a negative for most companies as it can lower their earnings ability and dividends.  This can discourage investors from the share market.

Monetary Policy

These are policies which can affect the supply of money and in turn affect the consumption of individuals. Technically it is the Reserve Bank of Australia (RBA), not the government, which implements monetary policy. The RBA is the “government’s bank” and it can lower the cost of money by decreasing interest rates and borrowing costs. A decrease in interest rates lowers the cost of borrowing. This allows businesses to increase investment and generate more jobs. It also encourages households to spend and borrow more money from banks. More spending from households can increase the GDP. We wrote an article previously on impact of the cash rate on the economy.

Fiscal Policy

These are policies where the government adjusts its spending levels and tax rates to influence a nation’s economy. The level of tax which is imposed on individuals will affect amount of money they will be able to spend on goods and services. If the government wants to stimulate the economy, they can decrease taxes. This will give individuals more spending power due to higher after-tax pay.

The Government can also affect the economy by deciding how to spend their tax revenue.  They can do this by spending more money in the public sector and perhaps hiring more people. They can also increase welfare payments or infrastructure projects which creates more jobs. If they can create more jobs, then this benefits the economy due to more people being able to buy goods and services and increasing the demand of the production of goods. Unemployment is an important issue for the government because it affects the taxes they receive from individuals. If unemployment is high, the revenue the government can collect is lower. It will also cause a reduction in consumption from households. This results in lower economic growth.

Recent examples of Fiscal Policy

The recent budget consisted of various measures to decrease the tax that individuals pay.  This included the elimination of the 37 per cent tax bracket and various tax cuts for most income percentiles.  Wage growth in Australia has been low in the last few years so the objective of the government to decrease the tax rates was to offset this factor and boost the after-tax income of tax payers in order to generate consumption.

In a more extreme example, in 2009 Kevin Rudd executed a stimulus package to avoid the global recession that was taking place. People were given a direct cash bonus to spend money to revive the economy by increasing household consumption.

Lauren Hua is a private client adviser at Fairmont Equities.

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