Returning the Australian Government’s finances to a sustainable position following the global financial crisis continues to present a challenge for government. While the 2017–18 Budget projects a return to surplus and a decline in net debt, these projections are subject to risk and uncertainty.
Australia’s fiscal position is sensitive to changes in economic growth. Government revenue, in particular, is sensitive to variation in the growth rate of the nominal economy. Changes in economic growth can be temporary, where a shock affects the current level of activity but does not affect the long-run level of output of the economy. Alternatively, a change in economic growth can reflect a structural change in the economy, such as an enduring change in the rate of productivity growth, and hence affect the ongoing growth in output.
This report analyses the impacts on the budget of different economic growth scenarios over the medium term. It also looks at the effects of lower long-term interest rates, which affect the cost of servicing government debt.
Temporarily stronger or weaker economic growth compared with the central projection has only a small impact on the government’s budget position over the medium term. This is because the impact of the shock on the level of real GDP dissipates over time and the budget impact is limited to the effect of the shock on prices.
In contrast, permanent changes in economic growth due to changes in the rate of productivity growth have significant impacts on the budget which will increase over time.
Permanently stronger economic growth benefits the budget position to the extent that the additional revenue is not spent or given back as tax cuts (beyond the assumed tax cap of 23.9 per cent of GDP). Permanently weaker economic growth has a significant impact on the budget position as tax receipts weaken with slower economic growth while government spending remains broadly unchanged and rises further as debt servicing costs rise.
These results reinforce the importance to the budget of continuing efforts to enhance the long-run productive potential of the economy.
There is also uncertainty around the level of long-term interest rates which underlie the medium-term budget projections. Interest rates, internationally and domestically, remain persistently low and it is unclear when (or whether) rates will rise back to long-run averages.
Lower interest rates on Commonwealth issued debt, all other things being equal, reduce public debt interest costs and improve the underlying cash balance. However, these improvements would be small because the stock of Australian Government net debt as a proportion of GDP is relatively low.
These scenarios highlight the need to consider the uncertainty around medium-term economic projections in managing the fiscal position. Taking into account uncertainty is particularly relevant in the current economic circumstances given the ongoing debate around whether the subdued economic outcomes of the past several years reflect a temporary or permanent phenomenon.