Analyse the causes and effects of fluctuations in Australia’s external stability.
Achieving external stability is an important objective of economic policy, achieving this stability
ensures that imbalances in Australia’s economic relationships with other economies do not hinder
achieving domestic economic policy goals such as lower rate of unemployment, higher rate of
growth and lower inflation. There are three main factors that affect external stability; the deficit on
the current account (CAD), net foreign liabilities and the Australian dollar. Australia’s experienced
times when overseas investors decided that the economy’s external position was unstable, and
when investors like such decide to withdraw their investment from the Australian economy it
creates a strain on the economy which can lead to a depreciation of the currency, higher interest
rates and slower economic growth.
The best way of assessing a country’s external stability is to look at the sustainability of its external
accounts, in particular the country’s foreign liabilities and the CAD. Since the 1980’s Australia has
persistently had a large deficit on the current account. Australia has paid out more for goods,
services, and income and transfer payments than it has received from overseas. As a country it is
irregular to have a CAD, usually countries aim for their economy’s to generate surpluses. The CAD as
a percentage of GDP is the best measure of trends in the current account over time, rather than the
size of the deficit in dollar terms. In the 1970’s GDP was calculated as a percentage and the CAD
averaged at 1.1%, in the 1980’s its average was 4.3%, this increase was viewed as a trade problem,
and believed it resulted because of an imbalance of goods and services. This large increase on the
deficit leads to major structural reforms to restore the competitiveness of the economy. However,
according to the Pitchford thesis (developed by John Pitchford); Australia’s high CAD is not a
significant issue currently as the majority of the foreign debt (95%) is from the private sector. He also
states that such borrowing is beneficial for Australia, as it provides funding for investment
opportunities that would otherwise not be capitalised on due to our low national savings rate.
Additionally, net foreign liabilities can cause crucial concerns in Australia’s external stability as they
have been rising since 1980. Ultimately, this concern can lead to debt sustainability issues, especially
if the size of Australia’s debt grows faster than the GDP. If this occurs, it will mean that Australia is
increasingly using a greater portion of the GDP to address the debt issue. Furthermore, international
financial markets may lower our international credit rating if they believe the debt is becoming
unsustainable. Consequently, it would reduce Australia’s growth rate as it would have reduced
access to overseas lending. It would also increase the servicing costs of new debts as interest rates
increase on foreign loans. However, whilst debt and liabilities have grown, so have Australia’s loans
to overseas nations and investment abroad. Nevertheless, Australia’s liability is still relatively larger
than foreign liabilities to Australia. Both Australia’s debt and liabilities have been growing at a slower
rate in recent years, which is reflected in the falling CAD and the fluctuations of Australia’s external
stability.
Similarly, the exchange rate has a significant impact on Australia’s external stability as all of trade
and financial flows require use of the Australian dollar (AUD). Speculative trade has made the AUD
relatively volatile; trade of AUD comprises of 6.7% of the Forex market making the currency the 6 th
most traded in the world. Exchange rates have significant impacts on our external stability, as it
affects the balance of payments. Since the price of the dollar affects the servicing costs of foreign
loans, it can severely influence the external stability. Thus, as the AUD is volatile, this means that one
of the most important indicators of external stability, the balance of payments, will also be
vulnerable. The vulnerability can adversely affect foreign investor confidence in Australia which can
undermine growth. Moreover, if investor confidence is low, it can lead to a mass exodus of foreign
liabilities in Australia, further reducing the exchange rate.
In order to resolve concerns caused by the fluctuations of Australia’s external stability; specific
policies are implemented to counteract the issues. Contractionary fiscal and monetary policy in the
1980s was aimed at reducing consumption and investment to lower CAD. Additionally,
microeconomic reform policies in the 1980s were aimed at lifting Australia’s efficiency and
international competitiveness. Similarly, the Howard Government adopted fiscal policy aimed at mid
– term stability, which was intended to ensure that the Government would not rely on savings used
to otherwise fund domestic investment; i.e. prevent the Crowding out theory. In recent years,
external stability has not been a major objective of microeconomic policy – this is because most of
Australia’s CAD from the private sector which doesn’t require government intervention. Many key
ideas of Australia’s economic framework indirectly aid in achieving external stability. Such examples
include boosting international competitiveness, constraining growth of foreign debt and maintaining
investor confidence in Australia. The GFC has led to Australia giving more thought to external
stability to avoid a severe debt problem in the private sector; observing the CAD and trade balance,
fiscal deficit, foreign debt, interest rates and inflation.
Hence, through a thorough analysis of factors which cause fluctuations in Australia’s external
stability, there is a strong conclusion that the effects which follow can have both beneficial and
detrimental impacts on Australia’s external stability and economy in general.