Reductions in Government Spending in the Orani-Naga Framework

In this paper, the ORANI-NAGA model of the Australian economy is used to examine the effects of a reduction in government consumption expenditure under two alternative scenarios. In the first, it is assumed that a 10 per cent reduction in government consumption expenditures is accompanied by an increase in private aggregate demand. In the second, it is assumed that the same 10 per cent reduction in government spending takes place, however private demand is held constant. One advantage of using the ORANI-NAGA model is that we are able to examine the effects of a budget cut on variables such as the public sector borrowing requirement and industry activity levels, as well as the macroeconomic effects. This study suggests that the predicted effects of a cut in government spending are sensitive to assumptions made concerning how the budget cuts are implemented. In the scenarios considered here, it is found that the change in overall economic activity, as measured by the percentage change in real GDP or employment, is similar in both cases but that there are substantial differences between the two in their sectoral effects, and in their effects on variables such as income tax rates and the public sector borrowing requirement.