External stability

Question 1

External Stability Definition

Answer 1

External stability is an aim of government policy that seeks to promote sustainability on the external accounts so that Australia can service foreign liabilities in the medium/long run and avoid currency volatility.

Question 2

The Pitchford thesis

Answer 2

The Pitchford thesis states that as long as a CAD is the result of savings and investment decisions by the private sector that are not the result of distortions to normal market mechanisms, then there is no cause for concern about an economy’s external stability. Australia’s CAD is different to other economies as the foreign debt is the result of foreign borrowings. Foreign liabilities helped to fund private investment projects or were direct investments in firms and ventures by foreign residents. However, the Pitchford thesis has been criticised for ignoring the risks and vulnerability of a country with large external imbalances when global economic conditions suddenly change.

Question 3

National debt

Answer 3

National debt comprises govt borrowings from OS and govt borrowings from Aust. It does not include overseas borrowings by the private sector.

Question 4

Net foreign debt

Answer 4

Net foreign debt is equal to gross foreign debt (the total amount of borrowing from OS) minus the sum of lending by Aust to OS and official reserve assets held by the RB.

Question 5

Net Foreign Liabilities (NFL)

Answer 5

NFL are equal to Australians financial obligations (foreign debt + foreign equity) to the rest of the world – the rest of the world’s financial obligations to Australia.

Question 6

CAD and debt trap scenario

Answer 6

In the long-term excessive growth in FD can lead to sustainability problem. If the size of the debt rises faster than GDP, then intertest payments take up an increasingly greater proportion of GDP. High CADs require a greater inflow of funds of either debt or equity. A larger FD requires more servicing which adds to the primary incomes account of the CAD. This can result in a vicious cycle known as the debt trap scenario.
If international markets think that debt may become unsustainable then the credit agency such as Moody’s reduces Australia’s credit rating which would increase the cost of borrowing as interest is higher

Question 7

MP

Answer 7

MP is not being used to address Aust’s external imbalances. Previously MP has been used to reduce consumer spending on M to create ST improvement in BOGS. This approach is now considered ineffective, as its impacts are only temporary and creates a slowdown in the economy. Higher IR can increase capital inflows, creating higher NPY outflows and worsening the CA. MP is unable to target the LT structural causes of Aust’s external imbalances.

Question 8

FP

Answer 8

FP has had some role in addressing low national savings. By adopting fiscal consolidation (running balanced/ surplus budgets), govts since the 1990s have reduces their call on private savings over the MT. In response to COVID, Josh Frydenberg has committed to reducing the BD when the economy recovers. This will lessen any upward pressure on IR and the crowding out of private borrowers.

Compulsory superannuation (requires employers to set aside 9.5% of wages) has lifted the level of national savings since the 1990s. It is a major contributor to the increased OS investment, which create financial inflows on the NPY. The govt’s policy to permit access to SA for those financially distressed by COVID has raised concerns about the sustainability of the system and its impact on domestic funds available for investment.

Question 9

Microeconomic reform

Answer 9

Microeconomic reform can be used to address the structural problems causing Aust’s external imbalances. The IC of Aust G+S should be improved by measures that lift the efficiency and productivity of Aust producers. These policies have included measures to reduce capacity constraints in the economy by improving infrastructure and alleviating skills shortages, removing protectionist barriers that shielded inefficient producers from OS and labour market reforms to increase productivity and workforce participation.

• Reforms (deregulation and privatisation) in the infostructure industries such as electricity, transport, water, gas, telecommunications – reduced costs, international competitiveness.
• National competition policy
• Cuts in protection
• Taxation reforms – increase incentives for productivity and saving and spending - lowering company tax rates to improve investment in Australia by making tax rates more competitive with other countries