Since almost eliminating net debt, the Australian Government%u2019s attention has turned to the financing of broader balance sheet liabilities, such as public sector superannuation. Australia will be developing a significant financial asset portfolio in the %u2018Future Fund%u2019 to smooth the financing of expenses through time. This raises the significant policy question of how best to manage the government balance sheet to reduce risk.
This paper provides a framework for optimal balance sheet management. The major conclusions are that:
%u2013 fiscal sustainability depends on both the expected path of future taxation and the risks around that path;
%u2013 optimal balance sheet management requires knowledge of how risks affect the balance sheet (and therefore volatility in tax rates); and
%u2013 the government%u2019s financial investment strategy should reduce the risk to government finances from macroeconomic shocks that permanently affect the budget.
Based on this framework, we find that a Future Fund portfolio that included (amongst other potential investments) domestic nominal securities and equities of selected countries would reduce overall balance sheet risk.
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