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Can fiscal policy help Australia bring inflation down?
Tighter federal and state fiscal policy would help return inflation to target and reduce the need for further RBA tightening.
Why coordination matters
Fiscal policy covers government choices on tax and spending. It has a major effect on growth and inflation. It can also redistribute income and shape the economy’s productive capacity and productivity.
Monetary policy works differently. It influences demand mainly through the cash rate, a broad rather than targeted tool. Strong coordination between the two policies is therefore preferable.
Politics complicates coordination, helping explain central-bank independence and a clear inflation mandate. In principle, inflation reflects the balance between demand and supply.
The Treasurer-endorsed 2023 RBA review called for better monetary-fiscal coordination. The question is whether that has happened.
Inflation has stayed high
The RBA’s preferred underlying-inflation measure, the trimmed mean, has exceeded the 2.5% target midpoint for four and a half years, suggesting persistent excess demand.
In our view, the RBA cut rates too early and too far in 2025. The US trade shock proved milder than expected, while weak productivity and stronger government spending brought capacity constraints forward.
The limited impact of the Trump tariffs – especially the absence of stronger imported disinflation – also surprised us.
Fiscal policy has added to demand
There are two main ways to assess the stance of fiscal policy. Both suggest it has been expansionary and has added to the inflation challenge.
First, the budget balance delivered a positive fiscal impulse last financial year and is expected to do so again this year. Off-budget spending adds further stimulus.
Second, spending beat forecasts in each of the past five six-monthly updates. Recent drivers included the National Disability Insurance Scheme (NDIS), GST payments, home-battery subsidies and disaster relief.
The Parliamentary Budget Office also finds federal and state forecasts too optimistic because expiring programs are often extended or replaced. Overall, the evidence points to expansionary fiscal policy that also surprised the RBA.
Why slower public-demand growth is not enough
Moreover, any rise in public demand still adds to demand in the economy and to inflation pressure. Public demand rose by 2.1% year on year in the second quarter.
Weak productivity lowers the economy’s “speed limit”. If public spending and AI-related data-centre construction keep expanding, households and non-technology businesses must slow for inflation to fall.
What governments could do
In our view, tighter fiscal policy would ease demand and help the RBA return inflation to target. The federal government could use the coming mid-year update to consider further spending cuts.
Priorities include keeping the May-budget NDIS slowdown on track, limiting off-budget spending, subsidies and tax breaks, and restraining public-sector hiring and wages.
Because many pressures are structural, options also include more targeted policy and tax reform, including higher consumption taxes.
States also have a role. New South Wales, for example, has set a debt ceiling of 15% of gross state product and plans to cut debt by AUD10bn.
Without slower spending or higher taxes, the RBA must do most of the work, risking a deeper downturn or recession.
Could the institutions change?
If coordination remains ineffective, institutional reform could help. Strengthening the Charter of Budget Honesty with a goal of balancing the budget over the cycle could complement the RBA’s inflation target. A deficit sits uneasily with full employment, high inflation and high commodity prices—conditions that historically often produced surpluses.
A bigger step would be an independent fiscal authority, an idea we discussed in 2017. It could adjust a cyclical tool such as the GST or superannuation guarantee charge.
Although fiscal policy is often seen as slow, it acted rapidly after the 2008 financial crisis and during COVID-19. New tools could make it faster, more targeted and better able to tighten as well as support the economy.
The budget balance is in deficit with more spending ‘off budget’ too…
Federal Government Budget Balance
...while policymakers’ spending has consistently surprised to the upside
Public spending surprises relative to budget forecasts
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