Key Facts about the Australian Economy:

There are three things you probably should understand about how the economy works:

  1. The federal government’s spending is not limited by tax revenue or amounts it can borrow.
  2. Unemployment is caused by a lack of combined spending (also called aggregate demand) from domestic firms and households; from foreigners buying Australian exports; and from the government sector. When the sum of spending from these 3 sectors goes down, unemployment goes up
  3. A government surplus means a non-government deficit, which leads to either unemployment (from reduced spending) or increased private debt (borrowing to spend)

Important Fact #1: The federal government’s spending is not limited by tax revenue or amounts it can borrow

The federal government issues the Australian dollar. When it spends it actually creates new money by increasing account balances of the payee and their bank. It does this many times every day. These balances didn’t exist before the spending. Government spending increases the money supply. When taxes are paid to the government, the opposite happens. The money supply shrinks - money is destroyed. Of course the bean counters can count how much is spent and how much is taxed and declare the size of the budget deficit or surplus but this information is meaningless and a government’s policy should never be based on a target budget balance.

Think carefully about this for a moment. Why would the Australian government need to earn Australian dollars from tax before it can spend it when it can create dollars whenever it wants? It doesn’t. Why would it need to borrow Australian dollars when it can create as many dollars as it wishes to whenever it likes? It doesn’t. It is nonsense to pretend that the Australian government’s finances are like the finances of a household. It can never run out of money and it can never be forced to “go broke”.

Important Fact #2: Unemployment is caused by a lack of combined spending

When households are buying things in Australia, when firms are building new premises, when foreigners are buying our exports and when the government is paying for goods or services, workers are needed to produce or provide the things being bought. When spending goes down, whether because of reduced spending by households, firms, foreigners or the government, workers are laid off. It then doesn’t even matter if wages are reduced, firms will not employ more workers if they cannot sell the good or services produced by the additional workers. Also, if wages are reduced across the economy, spending will go down even further as workers are also consumers.

When the government announces triumphantly that it has cut government spending in its attempt to reduce the deficit, what effect will that have? If the other sectors do not increase their spending then higher unemployment will follow.

As at August 2016, there were 721,000 people officially unemployed (meaning they worked for less than 1 hour per week) while in the same time frame (May 2016) there were 171,900 job vacancies. This large mismatch between job vacancies and people looking for work is not going to be solved by making the unemployed people look harder. It can only be solved by increasing the demand for workers and this can only be done by increasing spending. If the non-government sector won’t or cannot increase spending then the government must.

Important Fact #3: A government surplus means a non-government deficit

One thing our politicians neglect to tell us when they are talking about the intentions to return the government financial balance to surplus is that a government surplus means a non-government deficit – by definition. Think about it. A government surplus means that the government is draining more money from the non-government sector via taxes than it is injecting via spending. That’s what a surplus is. Regardless of the number and value of transactions between people or firms within the non-government sector, in total the sector will be worse off financially when the government runs a surplus. This is not a good thing especially when Australia already has the highest household debt among the OECD countries because to maintain spending, living standards and employment households will have to take on even more debt. Or, more likely, people will tighten their belts, reduce spending and increase unemployment. That’s not what we want so why are we told that government surpluses are good things?

On the other hand, when the government runs a deficit, the non-government sector will be in surplus, by definition. The financial wealth of the non-government sector will increase as more money is injected into it than is drained by taxes. This will allow households to spend more, save more or pay down some of the record debt they are holding. These are good things. So why are we told government deficits are bad things?

When you take the time to think through the impact government fiscal balances have on the non-government sector, you will see that government surpluses are unsustainable and that government deficits are sustainable. The exact opposite to what we are being told.

If you studied any economics at high school or university you may not remember being taught these facts because you were not. Current mainstream economics is based more on ideology than a sound representation of how a modern economy works so you will have been taught a number of myths that make you question the above. Please go here to see your questions answered.