Question

From 1974 to 2018 Australia ran a current account deficit every year. Over that period Australia’s trade deficit was also in generally in deficit but almost always smaller than the Australian current account deficit due to interest payments on foreign debt and dividends paid overseas.

1. Explain what this means for export, imports, income received from overseas and money paid overseas for Australia.

2. What has the consequence of the current account deficit been on the Australia’s financial account balance over this period? Did Australia experience a net capital inflow or outflow over this period?

3. Use the saving and investment equation to explain why Australia experienced net capital inflow or outflows from 1974 to 2018.

In 1986 the current account deficit approached 6% of GDP, and on May 14, Paul Keating infamously told radio presenter John Laws that Australia was in danger of becoming a “banana republic”. To get spending down, and thus reduce the current account deficit, he tightened the budget, recording a $9.1 billion surplus and encouraged the Reserve Bank to push interest rates to stratospheric levels. The cash rate hit 18% before helping push Australia into recession.

4. Did the budget surplus in 1989-90 help or hinder in reducing the current account deficit?

5. Did the higher interest rates help or hinder in reducing the current account deficit?

6. Australia’s current account deficit averaged 5% of GDP from 1990 to 2016 (and getting as high as 7% of GDP in 2004 and 2007). Why did concern about the current account deficit wane over this period?

Answer 1

Ans ) Interest payment to other countries as repayment of borrowed money will increase the interest rate which is clearing market in Australia. The interest rate will increase ,some of the money will go out of the country in payment of interest on debt or repayment of debt to other countries, this will reduce the money available in the country as a result the interest rate will increase in country to meet the demand for money in the economy. The country's currency will appreciate in terms of other countries currency. The trade will decrease as export of Australia is now costlier then other country in international market. Increase in interest rate will effect Australia in other situation also by appreciation of currency the capital inflow will increase. As investors will invest in Australia to earn high interest or yield on particular currency in financial market.

As the saving of the people will increase with the increase in interest rate because there is negative relationship between rate of interest and investment. The income of the people will decrease because of the decrease in investment as well the the investment due to multiplier effect the income and consumption will decrease.

The tight monetary policy by monetary policy results in the control of international financial market. Australian government decrease interest rate to decrease the demand of Australian currency in the international market so that the country can be in equilibrium or to reduce the current account deficit.

If their is budget surplus then the current account deficit can be reduced as this will effect the borrowed capacity of the country now they don't have to borrow from other country. With this the interest rate will also decrease, increase in money supply in the country as government have more money then earlier, this will effect the economy in positive way directly. Increase in investment, this will increase employment due to multiplier effect. This further increase the demand as well expenditure of the country. So the current account deficit can decrease further of the increased budget surplus is put into long run profitable project.

Increased in interest rate first directly increase the Current account deficit as now government have to pay debt more interest. Income of the people will decrease due to the decrease in the investment in the country.