Economics

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Review exercise 3

  1. What is a CAD?
    A CAD (current account deficit) occurs when the money flows of export receipts, service credits, inflowing income and current transfers are less than the money flows of import payments, service debits and outflowing income and current transfers overseas. So, if total debits are greater than total credits there is a CAD.

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  2. Outline some economic factors that may have contributed to the CAD.
    1. Australia's export base is heavily weighted towards primary products. The prices and demand for primary products reflect movements in the international business cycle. For example, the Asian economic crisis in 1997 and the global recession during 2001-2002 would have reduced Australia's export earnings.
    2. The terms of trade can also affect the CAD, for example in second half of the 1990s the terms of trade deteriorated. This means that the same volume of exports now purchases less imports. The deficit on the balance of goods and services increased and so did the CAD and foreign liabilities.
    3. The cost of servicing foreign liabilities is a major problem. As the level of foreign liabilities increases so does the net income component of the current account. Higher overseas interest rates or a depreciation in the value of the Australian dollar increase debt repayments and debt servicing as recorded in the CAD.
    4. One major area of concern is has been the lack of international competitiveness. Australian exporting industries historically lacked competitiveness, thus leading to deficits on the balance of trade.

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  3. Explain why the GFC helped reduce Australia's CAD.
    The GFC meant that there was a decline in available finance around the world, including Australia. This led to a slowing in levels of demand in Australia, leading to a decrease in demand for imports. Further, the fall in the value of the AUD made imports more expensive. This decreased demand for imports helped reduce the CAD.

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  4. Give an outline of the 'Pitchford thesis'.
    iv. The Pitchford Thesis states that if a current account deficit is caused by the sum of rational decisions in free markets made by individuals and institutions in trying to maximise their satisfaction (eg. Profit, return on investment) then it should not be of concern to governments and policy makers. For example, if an Australian business wishes to borrow money from a Japanese bank to fund productive expansion, and the Japanese bank is happy to lend the money at the agreed rate of interest, then the subsequent widening of the CAD simply reflects this transaction and so is not a problem.

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