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Tuesday, 21 August 1973
Page: 59

GENERAL

The economic impact of the budget is not restricted to the direct influence on expenditures and incomes discussed in Statement No. 2. The budget can also have significant effects on economic activity through its influence on monetary conditions^1)

The monetary effects of the budget can usefully be divided into two broad components. First, there is the direct impact of budget receipts and outlays on liquidity and the money supply. This can be measured by the budget domestic surplus or deficit - that is, the excess or shortfall of receipts in Australia over outlays in Australia. A domestic surplus, other things being equal, involves a withdrawal from the volume of money of an equivalent amount; a domestic deficit adds an equivalent amount to the volume of money.

The budget's monetary impact, however, is not determined only by the size of the domestic surplus or deficit but is also influenced by the way in which the surplus or deficit is financed. If, for example, a deficit in budgetary transactions is financed by a run-down of Government cash balances with the Reserve Bank, or by the issue of Treasury Bills to the Reserve Bank, the net increase in funds put out to the private sector as a result of the domestic deficit will for the most part end up in the banking system, so that there is an increase in the volume of money (as conventionally defined) and an increase in the liquidity of the trading or savings banks. If, however, the deficit were financed by sales of government securities to the nonbank private sector (whether by the Government direct or through Reserve Bank openmarket operations), the initial increase in the volume of money would be offset by the payments to the Government or to the Reserve Bank for the securities purchased.

The financing transactions associated with the budget thus have a major impact on the volume and composition of financial assets in the economy and may have a significant influence on the cost and availability of funds through direct and indirect effects on interest rates and the value of financial assets. Analysis of the monetary effects of financing transactions must take into account not only the movements in total holdings of government securities which may occur over a period but also the types and maturities of those securities and the classes of institutions or persons holding them. In particular, it is important to distinguish between changes in holdings of government securities by the banking system and by the non-bank private sector. An increase in the holdings of government securities by the latter group operates, as implied in the previous paragraph, to reduce the volume of money, while a reduction in these holdings has the opposite effect. An increase in the holdings of government securities by the banking system does not in the same way directly affect the volume of money or the total - as distinct from the components - of the LGS assets which constitute the general banking system's liquidity base.

Changes in holdings of government securities by particular groups are not, of course, solely the result of the budget. These holdings may be affected by the open market operations in government securities of the Reserve Bank and their bearing on relative interest rates. They may be affected also by other factors affecting monetary and liquidity conditions generally, including international trading and borrowing transactions, other Reserve Bank transactions with the private sector and, not least, demand for money as against less liquid financial assets such as government securities.

The stance of monetary policy is, of course, a very important influence on monetary conditions in the economy. Open market operations by the Reserve Bank, as noted above, and policy in regard to official interest rates and controls on the banking system may have important effects on the holdings of government securities by various groups and on the general cost and availability of funds in the economy through direct and indirect effects on interest rates and the value of financial assets. The effects of budgetary receipts, outlays and financing transactions on monetary conditions cannot, therefore, be considered in isolation. Clearly, monetary factors not only affect the level and pattern of economic activity but are also affected by general economic conditions. (') A detailed analysis of the monetary effects of the budget is contained in the Supplement to the Treasury Information Bulletin, National Accounting Estimates of Public Authority Receipts and Expenditure, August 1967.

THE FINANCIAL YEAR 1972-73

The following table shows selected financial series for recent years and for each half of 1972-73. A tabulation of budget financing transactions in 1972-73 is included in Statement No. 6.

Selected Financial Series _ (S million)

(a)   Includes government current account items which do not influence private sector liquidity.

(b)   Excludes government capital transactions and includes marketing authorities transactions, other private capital inflow and the balancing item. This last item includes net errors and omissions, and balances to a net monetary movements figure on an official parities basis rather than a market values basis.

(c)   These estimates differ from those published previously because of some accounting changes, the most important of which is the treatment of the net advance to the Australian Wheat Board as an outlay item in the budget rather than as a financing transaction.

(d)   Average of weekly figures basis. (Savings bank deposits are interpolated 'weekly average' figures based on end of month figures.)

(e)   Defined as LGS assets of the private sector. LGS assets of the trading banks and notes and coin in the hands of the public are included on an average of weekly figures basis while other items are on a last day or approximately last day basis. (/) Last day or approximately last day basis.

(g)   Share capital and secured and unsecured borrowings of societies (other than borrowings from governments and banks).

The domestic deficit directly added about $215 million to private sector primary liquidity and the volume of money over the 1972-73 financial year. This was larger than estimated at the time of the budget and was the first domestic deficit for some years. The size of the actual deficit compared with the budget estimate is. discussed in Statement No. 6.

Other factors also contributed to the rise in liquidity in 1972-73. Taking the year as a whole there was a very much reduced net inflow of private capital from abroad but a large balance of payments current account surplus. While, in the face of the build-up in liquidity, there was a large take-up of government securities by the private sector as a whole during 1972-73, the non-bank private sector ran down its holdings slightly over the year. Bank lending responded to the relaxation of monetary policy which had occurred and to the easier liquidity situation and bank advances outstanding rose very strongly during the year. These factors contributed to a very large rise in the volume of money during 1972-73.

Figures for the year as a whole, however, mask some significant changes within the year. The seasonality of budgetary transactions, of course, imparts a significant seasonality to movements in monetary aggregates. Additionally, however, during the course of 1972-73 policy decisions and other developments had a marked impact on monetary movements.

During the first half of 1972-73 Australian Government budgetary transactions resulted in a domestic deficit of $1,351 million - roughly $120 million greater than in the corresponding period of 1971-72 - and added substantially to private sector liquidity. At the same time private capital inflow into Australia continued at a very high level and its expansionary effects on domestic liquidity were reinforced by a growing surplus on the balance ofpayments current account. During this period then, the liquidity of the private sector built up strongly from the already relatively easy liquidity situation at the beginning of the financial year and, as noted above, bank lending expanded strongly in response to the easing of monetary policy which had occurred during 1971-72.

Despite the strong build-up in liquidity during the first half of 1972-73, demand for government securities by the non-bank private sector was only moderate so that the rise in liquidity was reflected in strong growth in the volume of money. The volume of money increased by 16.7 per cent in the six months to December 1972 compared with an increase of 7.7 per cent in the corresponding period of 1971-72. Growth in both fixed and current deposits with the trading banks was particularly strong.

During the second half of the financial year, budgetary transactions, although producing a seasonal surplus, had a considerably less restrictive impact on liquidity conditions than in corresponding periods of recent years. The domestic surplus during the six months to June 1973 was $1,137 million, considerably less than the figure of about $1,640 million during the corresponding period of 1972. The surplus on balance of payments current account transactions continued to rise, although there was a marked turnaround in private capital flows in this half-year and this acted to offset to a considerable extent the other expansionary influences on domestic liquidity. Bank lending expanded very strongly from February onwards. With the economy advancing firmly, however, it was considered prudent to modify the easy stance of monetary policy which had prevailed since December 1971 and on 9 April it was announced that the Statutory Reserve Deposit ratio of the major trading banks would be increased from 6.6 per cent to 7.6 per cent.

Demand for funds by the private sector meanwhile was being stimulated by the rising level of activity in the economy and private sector interest rates began to rise in the Autumn. With the Reserve Bank a reluctant buyer in the market for government securities in order to avoid adding to the liquidity of the private sector, market yields on government securities

 

also rose significantly. These higher market yields were reflected in the terms offered in the Government's May loan, with the long-term security carrying a yield of 6.5 per cent or 0.5 per cent above the rate offered on the corresponding security in the February loan.

In brief, during the second half of 1972-73 the strong upward trend in liquidity in the economy was interrupted and the easy stance of monetary policy was modified. None the less, due to the high degree of liquidity at the start of the period, financial conditions remained relatively easy. During the six months to June 1973 the volume of money increased by 7.7 per cent compared with an increase of 2.6 per cent in the corresponding period of 1972.

Shortly after the beginning of the new financial year, on 6 July, the Governor of the Reserve Bank announced that monetary policy was being directed further towards restraint and that the Statutory Reserve Deposit ratio of the major trading banks would be increased by two per cent - one per cent on 2 August and one per cent on 28 August. At the same time the Governor announced a release of 0.6 per cent from Statutory Reserve Deposit Accounts for the replenishment of the Term and Farm Development Loan Funds of the major trading banks.

On the same day the Treasurer announced the terms for the Australian Government's July cash and conversion loan. The terms offered were in line with the higher yield pattern which had emerged in the market. Yields on short-term and long-term securities were respectively 0.6 percentage points and 0.5 percentage points higher than yields on comparable securities in the May loan.

PROSPECTS FOR 1973-74

As indicated above, one important aspect of the influence of budgetary transactions on monetary conditions is the seasonality which budgetary transactions impart to movements in monetary aggregates. This seasonality is mainly the result of the pattern of Australian Government receipts during the financial year and one important element of this has been the payment of income tax by companies towards the end of the financial year. The decision announced in the Budget Speech to move progressively over three years to a system of quarterly company tax payments will therefore have important implications for the pattern of monetary movements within future financial years.

An indication of the significance of the new arrangements for the payment of company income tax may be gained from the fact that in recent years the proportion of company income tax collected in the first half of the financial year has been less than 4 per cent of the total for the year as a whole. Assuming that recent historical patterns of payment of company income tax would otherwise have prevailed, the requirement that companies should now pay an instalment in the region of 25 per cent of the tax payable during 1973-74 by 1 January 1974 suggests that an additional amount of the order of $330 million from this source will be collected in the first half of 1973-74. Correspondingly less will then be collected in the second half of the financial year. Even in this first year of the phasing-in arrangements there will, therefore, be a significant 'smoothing' of seasonal movements in liquidity in the economy.

There are, as usual, many uncertainties in the way of predicting the course of monetary conditions over the year ahead.

It is estimated that for 1973-74 as a whole the budget will produce a domestic deficit of the order of $160 million. On this basis the budget would therefore contribute somewhat less to domestic liquidity than in 1972-73. As suggested above, however, the impact of the budget on monetary conditions should be viewed in the context of the totality of relevant factors. One such major factor is that the financial year began with liquidity relatively somewhat below its excessive level at the start of 1972-73.

Monetary conditions through 1973-74 will also, in part, depend on the outcome in respect of private sector international trading and financing. While considerable uncertainty attaches to such estimates, it appears that the contribution of external account transactions to domestic liquidity will be less in 1973-74 than in 1972-73.

Finally, monetary conditions during the period ahead will depend on the whole range of domestic factors bearing on the demand for and the supply of funds in the economy - factors which, in turn, will themselves be in part the product of monetary policy during the year.







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