logo image

The balance of payments seen in the Australian economy

The balance of payments is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorised. These are the current account, capital account and financial account. In the current account, goods, services, income and current transfers are recorded. The balance of current account tells us if a country has a deficit or a surplus. The variables that go into calculation of current account balance are

X= Exports of goods and services

M= Imports of goods and services

NY = Net income abroad

NCT = Net transfers

CAB = X-M+NY+NCT

A deficit reflects an economy that is a net debtor to the rest of the world. It is investing more that it is saving and is using resources from other economies to meet its domestic consumption and investment requirements.

Comparison of Australia’s current account deficit with another OECD country

Australia has traditionally run a current account deficit, as investment opportunities have exceeded domestic saving. The deficit has been quite volatile, reflecting cyclical influences on saving and investment. Changes in income stemming from swings in the terms of trade have mainly affected the

Need essay sample on "The balance of payments seen in the Australian economy"? We will write a custom essay sample specifically for you for only $ 13.90/page

level of saving as spending habits have been maintained. The level of the current account deficit increased in the early 1980s and has averaged 4.75% of GDP since then (Appendix: Figure 1).

While there has been no obvious trend in the level of the current account deficit over the past decade and a half, there have been fluctuations around the average with significant upswings in the mid-1980s, late 1980s. By OECD standards Australia has an average saving rate, relatively high investment rate and a large current account deficit.

The figure 2 shows the economic indicators for Indonesia which is another OECD country. Large and persistent external deficits emerged for Indonesia as a result of unfavourable terms of trade shocks in the1980’s. The country implemented a major restructuring effort, reviving growth and reducing these imbalances. While the current account deficit was 1.6 per cent of GDP during 1988-89, it has risen above 3 percent of GDP since 1990 as private investment has surged.

Susan Collins in her paper “Experiences with Current Account Deficits among Asian Economies: Lessons for Australia “addresses four important issues. (www.rba.gov.au/PublicationsAndResearch/ Conferences/1994/Collins.pdf).

First, Indonesia has maintained relatively high levels of investment during crisis period. Some of the strong investment is a result of activist government policy. Secondly Indonesia borrowed heavily during their adjustment periods, enabling them to maintain relatively high levels of investment in the face of relatively domestic saving. The ability to borrow appears to have smoothed the adjustment phase, helping to maintain real growth rates. Third, authorities in the high performing Asian economies have maintained relatively prudent macroeconomic polices. In particular, this has meant relatively low budget deficits, and significantly positive levels of public saving. It has also meant being willing to adjust policies quite early in response to a downturn in economic indicators. Finally, the Asian country experiences highlight the role of national saving. A striking achievement of the initially low savers has been the dramatic increase in private saving rates since the 1960s.

These saving rates appear to have lagged the rapid rise in real growth, and not to have

‘come first’. The experiences suggest the initial rise in investment (financed largely by foreign saving) raised economic growth, which pulled up saving and triggered a virtuous cycle in which the dependence on foreign borrowing was reduced.

Policy Implications

Borrowing can be a bad thing if there are wrong incentives (bad tax policy, government guarantees, etc) encouraging individuals and firms to borrow too much. Borrowing helps drive economic growth. The key role of financial markets in a successful economy is to promote borrowing: that is, financial markets move funds from those with a surplus to those with a deficit who have productive investment opportunities. If the borrowing channel were to be cut off, these productive investment opportunities would never see the light of day, thus making for an inefficient and slow growing economy. The standard criticism of current account deficit is that the net indebtedness they create will have to be paid back by lowering standards of living in the future.

However, if foreign borrowing was used to make a productive investment, the result will be that output will grow so much that consumption in the future will rise even after the loans are paid back. If the external capital is used for sound productive purposes, i.e they generate assets which are hard working then it should more than enough to pay for itself over time and need not impose any burden on the present or future Australians. Future generations are likely to be richer than the present one and that borrowing which is well invested could prove a positive bequest rather than a liability. Foreign savings to fund domestic investment is a perfectly sensible course to follow, provided the returns from doing so are sufficiently high.

The solution to a problem of an inappropriately high current account deficit is to create the right private incentives for savings and investment. This requires focussing on what distortions in private markets might be leading to non-optimal amounts of savings or investment, and then deciding how these distortions can be eliminated or alternatively, offset by other microeconomic polices.

For example, evaluation of the incentives for dissaving arising from the Australian

government pension system might indicate that superannuation contributions should be raised in order to get people to save the appropriate amount for retirement. By using superannuation to compensate for the distortion created by the government pension system, private saving would be closer to the optimal level and the current account deficit would shrink. Forced savings for retirement indeed has been part of the policy package in Singapore which raised savings rates and helped reduce current account deficits. An important point about this kind of policy response is that it does not focus on the current account deficit per se. Instead it identifies a distortion in the market and then tries to correct the distortion with microeconomic policies.

Using monetary policy to eliminate current account deficit will not work for an open economy with flexible exchange rates like Australia. Tighter monetary policy reduces current account deficit by raising saving and lowering investment. However, in an open economy with flexible exchange rates, the tighter monetary policy leads to an appreciation of the domestic currency which has offsetting effects on the current account. Monetary policy cannot control real interest rates in the long run and hence it cannot be used to correct a long-run structural problem of an imbalance between savings and investment. The attempt to use a policy which only works in the short run but not in the long run only results in a stop-go policy.

Prudent macroeconomic policies are an important element in keeping current account deficits from becoming a problem for a country. Price stability and financial stability should be maintained so that financial markets function properly, with the result that private investment and savings are optimal.

Policy Alternatives

The current imbalance between domestic savings and investment is not optimal. It is difficult to maintain the quality of government spending, while reducing the deficit, so there has to be a trade off between quality and size. National saving has been declining since mid 1970s mainly due to sharp secular deterioration in public sector saving. The decline in public saving stems from 3 causes – strong increase in current spending, especially on transfer payments, an erosion of the revenue base and a reduced need to save because of declining infrastructure needs.

The decline in private saving was due to number of factors including a slow-down in per capita growth, a trend in retirement of workers in their peak saving years. (EPAC 1988). The government should look for cost effective and equitable ways of encouraging private saving and explore ways of reducing existing disincentives to save. Low inflation is crucial to a positive saving environment and the government should continue to give it a high priority. Australia’s foreign debt has been incurred by private firms rather than the government hence to borrow for productive investment the opportunities are strong.

The following are the policy alternatives to the government,

1. Efforts at fiscal consolidation to raise public saving.

2. Continued efforts on structural reform

3. Willingness to borrow to finance private investment and maintain strong levels of private investment

4. Sustained effort to promote private saving.

The government should put in a long term saving strategy so that the risks will swing towards a more lenient policy approach to the current account deficit.

Can’t wait to take that assignment burden offyour shoulders?

Let us know what it is and we will show you how it can be done!
×
Sorry, but copying text is forbidden on this website. If you need this or any other sample, please register

Already on Businessays? Login here

No, thanks. I prefer suffering on my own
Sorry, but copying text is forbidden on this website. If you need this or any other sample register now and get a free access to all papers, carefully proofread and edited by our experts.
Sign in / Sign up
No, thanks. I prefer suffering on my own
Not quite the topic you need?
We would be happy to write it
Join and witness the magic
Service Open At All Times
|
Complete Buyer Protection
|
Plagiarism-Free Writing

Emily from Businessays

Hi there, would you like to get such a paper? How about receiving a customized one? Check it out https://goo.gl/chNgQy