Effect Of Sustained Budget Surpluses (1 Viewer)

[risole91]

I need to the effects of sustained budget surpluses.
In our trial, our teacher told us, but she couldn't give us a sweet answer.

Any help?

thanks,

 

[veloc1ty]

That was in my trial and I couldn't really work it out either... my problem was that you don't know the cyclic factors or anything so it's hard to work out what would happen based on the fact of sustained budget surpluses alone... isn't it?

 

[BackCountrySnow]

your bestfriend Michael asked me this. The reply is somewhere in continuation.

 

[risole91]

That was in my trial and I couldn't really work it out either... my problem was that you don't know the cyclic factors or anything so it's hard to work out what would happen based on the fact of sustained budget surpluses alone... isn't it?

Yeah exactly.
This means you probably did the trial i'm about to do
Even knowing this question prior to doing the exam is hard :S

 

[bling05]

Avoids the crowding out effect...

 

[moll.]

Sustained surpluses have a continued contractionary effect upon the economy, reducing medium term economic growth.

However, under the Howard government the surpluses weren't great enough and hence added to growth and inflationary expectations.

It provides a base for private borrowings as surpluses are saved in financial markets.

Cuts down on any remaining public debt, to the point that now we have negative debt (or a surplus of funds) in the public sector.

The saving of these funds for later spending (such as with the Building Australia Fund) adds to economic growth in the long-term as the surplus is invest, raising AD in the future.

Reduces the KAS (no need to draw on foreign funds), thereby reducing the CAD from a lower income account.

Due to the Washington Consensus (the general agreement by the IMF on responsible economic management) sustained budget surpluses are looked upon as a sign of a healthy economy, which aids investor and business confidence.

Less need for a tightening of monetary policy (which has more adverse effects upon households than a fiscal surplus), to control possible inflation.


That's all I can think of at the moment.

 

[lionking1191]

you talk about effects on all aspects of economy, there's a lot to talk about which is why it's an extended response question.

eg. E.G (aggregate demand and supply - injection = up spending = unplanned inventory disinvestment etc etc)
then relate to standard of living + income distribution

internal balance - implications for inflation, ugh can't think of mroe

external - CAD "twin deficit (which doesn't work)" lots to talk about on CAD, like how Howard tried to reduce its size through fiscal constraint.
also relate if you have time to crowding out effect, how that decreases available borrowing which contribute to a higher foreign liabilities in the global economy

something like that, in eco you culd link anything to everything

 

[veloc1ty]

Yeah exactly.
This means you probably did the trial i'm about to do
Even knowing this question prior to doing the exam is hard :S

Nah our teacher makes the exams himself from a bunch of different sources. How come you know a question that will be in it beforehand?

Sustained surpluses have a continued contractionary effect upon the economy, reducing medium term economic growth.

But there could be many stimulatory aspects in the budget, and the reason it's a surplus is because of huge tax receipts. I don't see how a budget surplus (without knowing anything of what is in it or the economic environment around it) can be assumed as contractionary. It's generally considered contractionary if it's an increased surplus or decreased deficit, but we don't have enough information to determine that.

 

[moll.]

But there could be many stimulatory aspects in the budget, and the reason it's a surplus is because of huge tax receipts. I don't see how a budget surplus (without knowing anything of what is in it or the economic environment around it) can be assumed as contractionary. It's generally considered contractionary if it's an increased surplus or decreased deficit, but we don't have enough information to determine that.

It doesn't matter if the surplus has increased or decreased from the previous year, there's still money coming out of the economy whenever it's a surplus.
Granted, a smaller surplus in one year would have a less contractionary effect than the previous year, but still a contractionary effect nonetheless.
For instance, the 1.1% increase in real spending for this year's budget will have an more expansionary effect on the economy compared with last year's spending.
But the fact remains that $21.7 billion has been taken out of the cirular flow of income.
Because this is an increase on last year's budget surplus, but spending has risen by 1.1%, tax receipts collected by the government must have grown by more that 1.1%.
So the contractionary effects of the increased tax receipts cancels out the expansionary effect of the increased spending.

Now if the budget surplus had fallen, to say $10 billion, spending must have grown faster than taxation.
But the tax receipts are still $10 billion more than the spending costs.
So this will take that $10 billion out of the economy, lowering AD and hence growth.
The economy will grow faster than if it had been a $21.7 billion surplus, but that only means that the budget is more expansionary, not expansionary in general.
There's a difference.
Over the long-term it doesn't matter year to year, only that they are in surplus and hence generally contractionary.

 

[veloc1ty]

So really, a budget surplus is considered contractionary in comparison to the effect on the economy of having a balanced budget. Because by having a $21.7b surplus, it doesn't mean you took $21.7b out of the circular flow, it means you didn't put that $21.7b back into the economy.

Maybe I'm being semantical, but here's a metaphor: you have a jug half full of water. This is the circular flow of income before the budget (let's pretend it's an instantaneous event). We have an extra half jug of water, which is the $21.7b surplus. If we withhold from putting the water of jug B into jug A, we are not being contractionary (there is still a half jug of water in A) but the result is considered contractionary because half a jug is less than the full jug that would have resulted if we had put jug B into jug A.

XD

 

[moll.]

So really, a budget surplus is considered contractionary in comparison to the effect on the economy of having a balanced budget. Because by having a $21.7b surplus, it doesn't mean you took $21.7b out of the circular flow, it means you didn't put that $21.7b back into the economy.

Maybe I'm being semantical, but here's a metaphor: you have a jug half full of water. This is the circular flow of income before the budget (let's pretend it's an instantaneous event). We have an extra half jug of water, which is the $21.7b surplus. If we withhold from putting the water of jug B into jug A, we are not being contractionary (there is still a half jug of water in A) but the result is considered contractionary because half a jug is less than the full jug that would have resulted if we had put jug B into jug A.

XD

You lost me.

But yeah, you're right when you said that a budget surplus is contractionary because we are comparing it to a balanced (or defecit) budget, not to other surpluses.

 

[veloc1ty]

I think in an exam situation I should take things at face value from now on. But hopefully for the trial question I can argue the point in class and not lose too many marks.

 

[lionking1191]

Nah our teacher makes the exams himself from a bunch of different sources. How come you know a question that will be in it beforehand?



But there could be many stimulatory aspects in the budget, and the reason it's a surplus is because of huge tax receipts. I don't see how a budget surplus (without knowing anything of what is in it or the economic environment around it) can be assumed as contractionary. It's generally considered contractionary if it's an increased surplus or decreased deficit, but we don't have enough information to determine that.

we are talking about fiscal stance here, an increase in revenue is irrelevant, it's about how much is injected/taken out of the economy

 

[veloc1ty]

we are talking about fiscal stance here, an increase in revenue is irrelevant, it's about how much is injected/taken out of the economy

Yes, see my second last post. I didn't think that anything had technically been taken out, just never put in.

 

[lionking1191]

yeah i get what you mean actually (i must say the jug analogy was quite confusing) but the whole definition of a fiscal deficit (seems we ignored the OP all along) in the first place is spending more than you get, ie. spending more than total revenue received - any increase in revenue is already taken into account, if you spend more than that still only then are you running a deficit

 

[michael1990]

I always thought to know the exact effect of a sustained budget surpluses we needed to know whether it was a contractionary or expansionary consectutive budget surplus.

Contractionary
21bn - 2002
31bn - 2003
41bn - 2004
Less money into the circular flow model.

Expansionary
21bn - 2002
11bn - 2003
1bn - 2004
More money into the circular flow model.

Thoughts?

 

[lolcal]

I always thought to know the exact effect of a sustained budget surpluses we needed to know whether it was a contractionary or expansionary consectutive budget surplus.

Contractionary
21bn - 2002
31bn - 2003
41bn - 2004
Less money into the circular flow model.

Expansionary
21bn - 2002
11bn - 2003
1bn - 2004
More money into the circular flow model.

Thoughts?

wrong because parts of the budget may stimulate aggregate demand anyway, i.e the $42.7 billion tax cuts > much much more demand than the slightly expanded fiscal outcome, and it's likely that the surplus will fall over the next few years as a result.

 

[moll.]

I always thought to know the exact effect of a sustained budget surpluses we needed to know whether it was a contractionary or expansionary consectutive budget surplus.

Contractionary
21bn - 2002
31bn - 2003
41bn - 2004
Less money into the circular flow model.

Expansionary
21bn - 2002
11bn - 2003
1bn - 2004
More money into the circular flow model.

Thoughts?

Wrong.

That's comparing the budget surpluses year-to-year.
It can and is done, but the question didn't mention specific surplus amounts, it asked us to talk about sustained surpluses in general.
Which means that we have to compare the effects to the alternate option: deficit/balanced budget.
A budget surplus is much more contractionary than a deficit/balanced budget, so sustained surpluses have a sustained contractionary effect on the economy.

Besides which, the surplus is the amount of money that has been taken out of the economy each year.
Not in total.
So each year there is money coming out of the economy, reducing AD and creating contractionary effects.
So a surplus of $10 billion the year after a surplus of $20 billion isn't expansionary, it's just more expansionary than the year before.

If you 'ken.

 

[risole91]

I always thought to know the exact effect of a sustained budget surpluses we needed to know whether it was a contractionary or expansionary consectutive budget surplus.

Contractionary
21bn - 2002
31bn - 2003
41bn - 2004
Less money into the circular flow model.

Expansionary
21bn - 2002
11bn - 2003
1bn - 2004
More money into the circular flow model.

Thoughts?

Do you even pay attention in class?