The limits of activist fiscal policy: new evidence reinforces old concerns

Personal reflections from Gene Tunny, Director, Adept Economics

The federal government implemented sizeable fiscal stimulus programs in Australia’s last two major economic shocks, the pandemic and the 2008 global financial crisis. As this article explains, our experiences with these programs have reinforced important lessons about the limits of activist fiscal policy. 

Activist fiscal policy means deliberate actions such as fiscal stimulus packages to influence economic conditions. It is distinct from the ‘automatic stabilisers’ that are already in the budget, such as unemployment benefits and proportional and progressive income taxes. While there may be a role for activist fiscal policy in the case of large shocks such as the pandemic, stimulus measures need to be carefully designed to avoid unintended consequences.  

This article is based on a recent episode of the Economics Explored podcast that I host. It features a previous conversation I had with the late Professor Tony Makin. You can listen to the episode wherever you listen to podcasts (e.g. Spotify) or via the embedded player below. 


JobKeeper had some benefits but was badly designed

The JobKeeper payroll subsidy program was a major part of the Australian Government’s response to the COVID-19 pandemic. The program had some positive aspects, such as sustaining businesses and keeping many people employed during a challenging time, but there were big concerns about the program’s design. Tony Makin had warned about the design flaws of JobKeeper in a June 2020 Centre for Independent Studies (CIS) paper, A Fiscal Vaccine for COVID-19. For example, one of Tony’s concerns was the flat payment structure of JobKeeper, which led to some part-time or casual workers earning much more than they would have otherwise. 

Treasury research published in December 2023 suggested that this design flaw had an unintended negative consequence during the recovery period: a reduction in workforce participation among the lucky casual workers at a time of strong labour demand in which concerns were raised about a shortage of workers. In a research paper titled The employment effects of JobKeeper receipt, the Treasurer analysts reported (on p. 2): 

“We also find suggestive evidence that JobKeeper receipt made casual workers less likely to be employed over a year later. These effects are far smaller and less statistically significant than the positive effects found during early 2020 but are not implausible – they could reflect income effects on labour force participation given JobKeeper led to some workers having substantially higher incomes than they otherwise would have.”

This finding may have been why the Treasury released this paper on the Friday afternoon before Christmas 2023. As my CIS colleague, Chief Economist Peter Tulip, suggested on Twitter/X, the Treasury may have been embarrassed by something in the paper. This unintended consequence reinforces the need for a more targeted and proportionate payment structure considering previous earnings in any future payroll subsidy scheme. 

Last year, an Independent Evaluation of the JobKeeper Payment was conducted by my old boss in the Treasury, Nigel Ray. Nigel raised significant concerns with the program’s design, although he broadly supported it, highlighting its macroeconomic support. He suggested a more flexible policy design could have allowed for payment adjustments based on actual business turnover after a few months rather than relying solely on forecasts of turnover by businesses. This would have helped to limit the fiscal cost of the program and ensure that support was directed to those who truly needed it.

The analysis from Tony, Nigel, and others underscores the importance of careful consideration and refinement of fiscal responses to ensure their effectiveness and mitigate unintended consequences. It is now clear that JobKeeper fell short of satisfying the Targeted criterion of former US Treasury Secretary Larry Summers’s fiscal stimulus criteria: Timely, Targeted, and Temporary (see Fiscal Stimulus Issues). JobKeeper did much better on the Timely and Temporary criteria than the Targeted criterion. 

Be wary of unintended consequences of activist fiscal policy

Another unintended consequence of the federal government’s pandemic stimulus relates to the housing market. The federal government’s HomeBuilder grant financially supported individuals building or renovating homes. However, it appears to adversely affect the building sector, significantly increasing the number of building companies collapsing. The grant contributed to a surge in demand for construction services, causing input prices to soar and making fixed-price contracts unsustainable for many tradies (see this media report, for instance, Casa Building Group collapses into liquidation, receivership owing $3.7m, Guzman Y Gomez sites impacted | As a result, builders and tradies could not fulfil their contracts, leading to financial difficulties and company collapses. Of course, it was not the only factor as interest rates went to ultra-low levels, but it appears it was significant. This example illustrates the importance of considering the potential consequences of fiscal policies. Policymakers must consider the implications of their decisions to avoid unintended adverse outcomes. 

Crowding out via interest rate and exchange rate effects

One of Tony Makin’s great contributions to the public policy debate in Australia was reminding policymakers to consider how the effects of activist fiscal policy can be ‘crowded out’ through various channels as the economy reacts to the fiscal policy shock. These can include price changes, as happened in the construction industry, or through interest rate and exchange rate impacts, which Tony argued offset the Rudd Government’s fiscal stimulus in 2008-09. 

As governments borrow money to fund their stimulus packages, they put upward pressure on interest rates as they compete with other borrowers for lending. This increase in interest rates, relative to where they otherwise would be, attracts capital inflows into the country, appreciating the currency, making exports less competitive and imports cheaper. This reduces net exports (i.e. exports less imports) and offsets the GDP boost from the fiscal stimulus to some extent. 

The extent of crowding out associated with fiscal stimulus is an empirical matter that is difficult to determine. In a response to a Minerals Council of Australia paper from Tony, the then Treasury Secretary Martin Parkinson pushed back substantially on Tony’s analysis of the Rudd Government stimulus, arguing economic and financial market conditions at the time meant the model he was using was not relevant (see Response to Professor Tony Makin’s Minerals Council of Australia Monograph – ‘Australia’s Competitiveness: Reversing the Slide’ | However, Tony was later engaged by the Treasury under a new Secretary, John Fraser, and produced a paper for the Treasury that set out his critique of activist fiscal policy (see The Effectiveness of Federal Fiscal Policy: A Review | Treasury Research Institute). It is beyond the scope of this article to fully review the debate on crowding out. Still, it is fair to say that policymakers need to consider the potential for crowding out when designing fiscal stimulus programs.  

Other considerations: workforce issues

Another consideration with some fiscal stimulus packages is whether they will be effective in employing the unemployed. In the conversation I had with Tony Makin about fiscal stimulus, he observed:

“…one other point to make about infrastructure spending, and this is one feature of government spending that Keynes instanced in his work originally right back in the 1930s. He talked about public works, which is effectively what we call infrastructure today, but the difference between then and now when you talk about boosting infrastructure spending is that the nature of the workforce has changed dramatically. I mean, people these days have certain skills, it’s a highly variegated work workforce with people doing different things. And the assumption in Keynes’s theory was you increase spending on public works, then you have workers easily transferred from jobs that they’ve lost places of employment where they used to be in factories and other areas of unskilled work and they can easily be transferred to, you know, working on the road, so to speak, but these days that seems far-fetched because, for instance, baristas who’ve lost their jobs are not necessarily going to be out there on the road as a construction worker, financial sector employees and not wanting to be putting pink bats in ceilings. So, the nature of the workforce is important. We can’t just treat the labour force as this homogenous entity where people can transfer across to any sort of industry at whim. And there’s information costs, transactions costs, which make the whole process a little bit trickier than it sounds in terms of increasing employment.”

This is an important observation, and I noted in response that there were good examples of public works programs in Australia in the 1930s that could employ otherwise unemployed workers (e.g. Mount Spec Road and Little Crystal Creek Bridge in North Queensland) but that there were fewer opportunities for such projects today given the changes Tony discussed.


Workers constructed Mt Spec Road and Little Crystal Creek Bridge in North Queensland in an unemployment relief program during the Great Depression of the 1930s. 

Ongoing burden of interest payments on government budgets

Finally, one impact of fiscal stimulus some policymakers do not understand is the ongoing budgetary burden from higher interest payments on government debt (Figure 1). This means governments have less to spend on priorities such as health and education, all else equal. Suppose governments are going to engage in activist fiscal policy. In that case, they should balance out any deficits they run due to activist policy with surpluses when the economy is in its expansionary phase. However, history suggests they do not, and there is a bias towards deficit financing. 


Key takeaways from our fiscal policy analysis include:

  1. Fiscal stimulus packages must be carefully designed and limited in size to avoid unintended consequences. As Larry Summers famously observed, they should be Timely, Targeted, and Temporary.
  2. Interest payments on debt associated with a fiscal stimulus can have long-term impacts on the government’s ability to meet its priorities, meaning less spending in essential areas or higher taxes than otherwise to service the debt.
  3. The effectiveness of fiscal policy in an open economy is influenced by factors such as interest rates, capital mobility and exchange rates. Movements in interest rates and exchange rates can counteract the effects of fiscal stimulus. 
  4. The nature of the workforce is important to consider when implementing fiscal policy, as not all workers can easily transfer to different industries.

This article was authored by Adept Economics Director Gene Tunny and published on 16 January and updated on 19 January 2024. For further information, don’t hesitate to contact us via or 1300 169 870.

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