Government spending and inflation by Robert Carling

Read the paper here: https://www.cis.org.au/publication/government-spending-and-inflation/

That government expenditure in Australia has grown apace in recent years is well-known. The growth became gargantuan during the coronavirus pandemic. However, to a less dramatic extent, it was happening before the pandemic — and has continued since it ended.

Some observers welcome this growth to the extent it is a reflection of new spending programs and expansion of existing programs perceived to meet legitimate needs. But it is also a matter of serious concern for reasons that include the implications for higher taxation and public debt, the effect on incentives and the diversion of scarce resources away from alternative and higher productivity activities.

Recently, attention has turned to the impact of higher public spending on inflation as monetary policy struggles to restore inflation to its target. Specifically, the Reserve Bank of Australia (RBA) has spoken of the high level of aggregate demand relative to the economy’s potential output. The RBA has drawn attention to the relatively rapid growth of public final demand as a contributor to excessive aggregate demand —­ although the Governor has also stated that public sector demand “is not the main game” in the policy response to persistent inflation.

This policy paper presents the key facts about public expenditure growth in recent years and discusses its contribution to inflation.