External Stability
CAD, BOP, TOT, NFD and the Australian
Dollar
Definition
External stability looks at how we transact with
other countries overseas.
When we purchase products made overseas this
is known as imports (M)
When they purchase products from us this is
known as exports (x)
Measurement of External Stability
There are three measures or indicators of external
stability:
1. The size of Australia’s Current Account Deficit
(CAD)
2. The exchange rate for the Australian Dollar
3. The net foreign debt (NFD).
CAD (X – M)
The Government aims to keep the Current
Account Deficit (CAD) at low levels of around 3%
of GDP
The CAD is a component of the BALANCE OF
PAYMENTS (BOP)
The Balance of Payments
The Balance of Payments account is an annual
statistical record of the money value of different types of
transactions between Australia and the rest of the world
Credits are money that comes into Australia (for the sale
of our exports)
Debits are money that flows out of the rest of the world (for
the purchase of imports)
The overall balance of payments account is divided
into the:
1. Current Account
and the
2. Capital and Financial Account
The BOP always balances and it is the Current
Account that we are most interested in.
Copy the diagram on pg 228 of your text book Economics Down Under Units 1 &
2
CAD
The Current Account is broken into four sub
accounts:
Net Goods
Net Services
Net Incomes
Net Current Transfers
Debits and Credits
Payments to foreigners on the current account
are recorded as debits
Payments received from foreigners to us are
recorded as credits on the current account.
When debits exceed credits then it will be
recorded as a deficit.
Difference between the Current Account and the
Capital Account
The current account records things that do not
result in any future obligations whereas the
capital transactions do result in future
obligations.
Eg loans and interest paid on those loans result
in future obligations and therefore are recorded
on the capital account.
Look at the table Components affecting Australias
current account deficit (CAD on pge 231)
Have a go at calculating how they got the figures in
table 8.3. Use table 8.2 to calculate the annual CAD
figures for the year ended 30 June 2010. Provide a
possible explanation for the movement in the CAD over
the financial years 2009 and 2010. (see my
spreadsheet calcs for help)
Answer Multiple Choice Qs 8 from 2011 exam paper
The Capital and Financial Account
(CAFA)
The financial Account in the CAFA is the most useful
thing for us to look at. Effectively it shows how we
finance our CAD.
If we import more than we export then we need to pay
for those imports. Typically Australia finances the CAD
in the form of loans (debt) or the sale of Australian
assets which leads to an increase in Australia’s net
foreign liabilities or NFD.
Answer questions on pg 157:
1, 4,5,6,7,8,9
The effects of Australia’s CAD and
reliance on OS borrowing
Australia has a large CAD, mainly because of
our heavy reliance on overseas borrowing and
foreign debt.
The interest on this debt is recorded in the
Current Account in the Net Primary incomes
section.
Weakens the exchange rate
When the CAD is large, this means we are
importing more than we are exporting.
To pay for the imports we need to supply
Australian Dollars Overseas.
When we supply more AUD overseas this places
downward pressure on the value of our dollar.
Increase the foreign Debt
A high CAD means we are importing more than
we are exporting.
To pay for this difference we need to borrow
money from overseas. This results in increased
Net Foreign Debt.
Net Foreign Debt must be paid back with
interest, which further increases the CAD.
Policies may be needed to slow
spending and AD
If the CAD is too high, the government may want
to slow spending on imports, but it is generally
only possible to slow overall spending, not target
imports directly.
Contractionary measures such as higher interest
rates or increased tax rises may be used which
has a slowdown on all economic activity.
Higher Interest Rates
If the size of the CAD is too high and leads to an
increase in our net debt this may adversely
affect Australia’s credit ranking. This could
result in higher interest rates charged on the
money we borrow from overseas.