• We are looking for new moderators to join the Bored of Studies team!
    Click here for details
  • Looking for HSC notes and resources?
    Check out our Notes & Resources page

Economics Essay Help (1 Viewer)

PastPaper

New Member
Joined
Aug 28, 2011
Messages
6
Gender
Undisclosed
HSC
N/A
I'm struggling with this question atm. Someone pls halp.
Analyse the causes and effects of the current account deficit on the Australian economy.
Thanks.
CAD sucks :(
 

BASS-Economics

New Member
Joined
Jun 26, 2013
Messages
6
Gender
Undisclosed
HSC
N/A
A lot of people seem to have trouble with this whole topic, so I decided to write out a full essay for it.
Analyse the causes and effects of the current account deficit on the Australian economy.

The balance of payments is the record of all of a country’s international financial transactions in a given year and consists of the current account and the capital and financial account. The current account consists of non-reversible transactions and includes Balance on Goods on Services and Net Income components. Australia’s persistently high current account deficit (CAD) is contributed to by structural and cyclical factors. Economists believe that a sustained CAD may have both positive and negative impacts on an economy such as Australia.

Australia possesses a structurally large savings-investment gap. This is contributed to by a low domestic savings pool (due to our low households’ savings ratio of approximately 12%, and small population of around 22million), and substantial investment opportunities in the economy, with a large country of many natural resources. Due this, Australia is a net importer of capital, as businesses must rely on foreign borrowing to finance their investments.

However, this leads to significant growth in Australia’s net foreign debt, reaching 51% of GDP in March 12 and servicing costs on this debt being the main contributor to the sustained high CAD, with Net Primary Income (NPI) being -3.2% of GDP, making up most of the -4.1% of GDP deficit on the current account. The NPI has remained at around this level since the 1980s, with the CAD averaging 4.6% in the 2000’s

The cyclical nature of the CAD is derived from changes in the Balance on Goods and Services (BOGS) component of the Current Account, which fluctuates with changes in the international and regional business cycles. This is determined by the level of economic growth in Australia relative to that of major trading partners. If Australia’s growth is relatively higher, domestic demand for imports will exceed overseas demand for Australian exports, thereby generating a BOGS deficit.

During the height of the mining boom in 07-08, the BOGS reached a deficit of -2.1% of GDP (causing the CAD to peak at 6.3% of GDP), which rose back up to a surplus of 0.6% in 08-09 due to faltering economic activity in Australia relative to the commodity export-demanding, emerging economies of China and India. With diminishing global conditions, with the continuation of the European Sovereign Debt crisis and falling economic growth in India and China, at approximately 6% and 8% respectively. However, Australia’s BOGS deficit has grown again to 0.8% (Mar 12), as we are experiencing the highest sustained Terms of Trade (at 117.5 in March 2012) in over 140 years, leading to a CAD of -4.1% (Mar 12). Hence, it can be seen that fluctuations in the BOGS is the main contributor to changes in the CAD, whilst NPI is the main contributor to the deficit itself.

A persistently high CAD can have both short term and long term impacts and can be interpreted as both positive and negative. The most dangerous potential impact of a CAD is the exposure of the Australian economy to international financial crisis. A number of factors make the Australian economy volatile to international conditions.

Most notable is growth in foreign debt, which demands great servicing costs on interest payments and the principal amount borrowed. Many businesses are borrowing even more funds from overseas to service pre-existing debt, leading to growth in foreign debt in the long term, as seen in our current level of foreign debt of 51% of GDP (Mar 12) growing from 44% in 2003-04. This is very evident today with the European Sovereign Debt Crisis drastically impacting the economies of Portugal, Ireland, Greece and Spain, where continuous fiscal deficits has generated a near-unsustainable level of public debt leading to low-confidence investors demanding higher interest rates, altogether facilitating the need of contractionary fiscal policy to pay off these debts.

However, since 95% of foreign debt in Australia is owed by the private sector, economists believe this may not be as much of a problem. The Pitchford thesis states that foreign debt owed by the private sector should be treated just like any other type of private sector debt, since investments increase the economy’s productive capacity, making it easily serviced. Nevertheless, high levels of foreign debt may diminish investor confidence, leading to lower productivity growth in the long term.

A high CAD may also lead to increased volatility of the Australian dollar. This is because speculators (who make up 95% of trade on the FOREX market) may lose confidence in an economy if it is unable to pay off its debt. This may depreciate the AUD in the long term, leading to an increase in imported inflation and may further increase servicing costs on foreign borrowings that are denominated in foreign currencies, a phenomena known as the valuation effect. Yet despite Australia’s persistently high CAD, this has not occurred. However, this effect is currently occurring with the Euro, as speculators are investing in alternative currencies such as the AUD, which has recently become the fifth most traded currency in the world.

The potential of these negative impacts has led to the Commonwealth government’s goal of keeping the CAD below 5% of GDP. Hence, should the CAD approach this level, the government may implement contractionary economic policy in response, limiting the potential of short term economic growth in Australia. This limitation is known as the Balance of Payments Constraint.

Regardless, there are still positive interpretations of a high CAD. One interpretation is that a high CAD enables more investment than would otherwise be possible, leading to greater living standards in the long term. Additionally, the capital inflows associated with a high CAD can be viewed as an indicator of foreign investor confidence in the Australian economy. So whilst a CAD may potentially damage an economy, it is also an indicator of strong economic performance.

Australia’s persistent CAD, whilst significant, is believed not to be harming the Australian economy’s performance in recent years, with the OECD describing the CAD as sustainable in view of economic policies in 2004. Though there are potential negative impacts of the CAD in the short and long term, IMF reports from 1995 onwards describe Australia’s Current Account and net foreign debt as sustainable and external risks as manageable, but advising that Australia’s net foreign debt position be monitored carefully. Hence, the CAD can be backgrounded in favour of other economic objectives in the short term future.
 

Users Who Are Viewing This Thread (Users: 0, Guests: 1)

Top