3.3 - Australia and the International Economy Flashcards
Open Economy
An economy that freely interacts with other economies in the form of trade and finance
Closed Economy
An economy that does not interact with other economies in the form of trade and finance
Exports
Goods or services produced in Australia that are sold to the world
Imports
Goods or services produced overseas and sold in Australia
Free Trade
When no restrictions are placed on the flow of goods, services and capital between nations
Barriers to Trade
Impediments to free trade in the form of tariffs, subsidies and quotas
Trade Liberalisation
The process of removing barriers to trade
Benefits of Trade
- Lower prices for consumers – as producers can access the cheapest supplies and labour, higher wage competition and increased competition → improved access to goods and services → improved material living standards
- Greater choice for consumers → improved consumers’ satisfaction → improved non material living standards
- Economies of scale – as producers can produce greater volumes to minimise fixed costs → reduced costs → improved access to goods and services → improved material living standards
- Access to more resources for business and government – in terms of physical, human and financial capital → increased ability for producers to produce → higher employment → higher incomes → improved material living standards
- Increased competition and efficiency → reduced costs → improved access to goods and services → improved material living standards
Balance of Payments
An annual record of the money value of different types of financial transactions between Australia and the rest of the world
Credits in Balance of Payments
Money received by Australia from overseas
Debits in Balance of Payments
Money received by overseas from Australia
Current Account
Records financial transactions that do not create any future obligations
Current Account Sub-accounts
- Balance of Merchandise Trade (Net Goods): value of export credits for goods sold overseas minus value of import debits for goods purchased from overseas
- Net Services: value of service credits received from overseas minus value of service debits paid abroad
- Net Primary Incomes: value of primary income credits received from overseas minus primary income debits paid abroad
- Net Secondary Incomes: value of secondary income credits received from overseas minus the value of secondary income debits paid abroad
Capital and Financial Account
Records financial transactions that DO create future obligations
Capital and Financial Account Sub-accounts
- Capital Account: includes net capital transfers and the net acquisition of non produced, non financial assets
- Financial Account: value of total credits for investments and borrowings received by Australians from abroad minus total debits for investments and lending abroad
o Financial Derivatives: complex financial instruments that create assets or liabilities
o Net Direct Investment: credits from purchase, establishment and expansion of companies and assets in Australia by foreigners minus debits from similar assets overseas by Australians
o Net Reserve Assets: credits from RBA and Government transactions involving reserves of foreign currencies, gold, special drawing rights and contributions to IMF minus debits from similar transactions
o Other Investments: credits from funds or assets minus debits
o Net Portfolio Investment: value of foreign individuals purchasing Australian shares, debt and securities minus the value of similar assets purchased by Australians
Structural Component of Current Account
- Relates to the aggregate supply side of the economy
- Causes:
o Savings/investment imbalance – less savings that investments requires foreign borrowing to finance investments
o Low levels of international competitiveness – due to low efficiency and high production costs
Cyclical Component of Current Account
- Relates to the aggregate demand side of the economy
- Strong economic activity → more imports
- Weak economic activity → less imports
Net International Investment Position
- The extent to which Australia is financially obligates to the rest of the world
- Made up of Net Foreign Liabilities, which is made up of Net Foreign Debt and Net Foreign Equity
Net Foreign Debt + Causes
- Calculated by total borrowing from overseas minus total lending to overseas
- Causes:
o Lack of domestic savings
o Many budget deficits
Public Debt
Government borrowings to finance budget deficits
Private Debt
Companies raising capital for financing business expansion and takeovers
Net Foreign Equity
- Calculated by the net equity obligation that results from foreign ownership of Australian assets minus Australian ownership of foreign assets
- Includes property and shares
Terms of Trade
- Ratio of the average prices received for Australian exports relative to the average prices paid for our imports
Terms of Trade Formula
Terms of Trade= (Export Price Index)/(Import Price Index) × 100
Impacts of Changes to Terms of Trade on Current Account
- Increase to the terms of trade → increased value of exports relative to imports → increased balance of trade → favourable movement to the current account
- Decrease to the terms of trade → decreased value of exports relative to imports → decreased balance of trade → unfavourable movement to the current account
Factors Affecting Terms of Trade
- Commodity prices
o Higher demand for commodities → higher prices → higher terms of trade
o Lower demand for commodities → lower prices → lower terms of trade - Production costs in trading partners
o Lower costs overseas → reduces Australia’s international competitiveness → lower terms of trade
o Higher costs overseas → increases Australia’s international competitiveness → higher terms of trade
Impact of Terms of Trade on Macroeconomic Goals
• Strong and Sustainable Economic Growth:
o Increased Terms of Trade → increased value of exports relative to imports → increased aggregate demand → increased production → increased economic activity → increased growth
o Decreased Terms of Trade → decreased value of exports relative to imports → decreased aggregate demand → decreased production → decreased economic activity → decreased growth
• Full Employment:
o Increased Terms of Trade → increased value of exports relative to imports → increased aggregate demand → increased production → increased economic activity → increased derived demand for labour → decreased unemployment
o Decreased Terms of Trade → decreased value of exports relative to imports → decreased aggregate demand → decreased production → decreased economic activity → decreased derived demand for labour → increased unemployment
• Low Inflation:
o Increased Terms of Trade → increased value of exports relative to imports → increased aggregate demand → moves economy closer to productive capacity → increased demand inflationary pressures → increased price inflation
o Decreased Terms of Trade → decreased value of exports relative to imports → decreased aggregate demand → moves economy further from productive capacity → decreased demand inflationary pressures → decreased price inflation
Measures of Exchange Rates
- Individual exchange rates
- Trade Weighted Index – value of AUD when compared to currencies of our major trading partners
Factors Affecting Exchange Rates
- Relative Interest Rates:
o If Australia has higher relative interest rates → increase demand for AUD
o If Australia has lower relative interest rates → decrease demand for AUD - Foreign Investment / Capital flows:
o Movement of money into Australia (capital inflow) → increase demand for AUD
o Movement of money out of Australia (capital outflow) → decrease demand for AUD - Demand for Exports and Imports:
o Increase demand for exports → increase demand for AUD
o Decrease demand for exports → decrease demand for AUD
o Increase demand for imports → increase supply of AUD
o Decrease demand for imports → decrease supply of AUD - Terms of Trade:
o Increased TOT = increased demand for Australian exports relative to imports → increase demand for AUD
o Decrease TOT = decreased demand for Australian exports relative to imports → decrease demand for AUD - Relative Rates of Inflation:
o If Australia has higher relative rates of inflation → decrease export demand and increase import demand → decrease demand and increase supply of AUD
o If Australia has lower relative rates of inflation → increase export demand and decrease import demand → increase demand and decrease supply of AUD - Credit Ratings:
o Higher relative credit ratings → safer investment → investors more wiling to invest → higher demand for AUD
o Lower relative credit ratings → riskier investment → investors less willing to invest → lower demand for AUD - Speculation:
o Expected that currency will appreciate in future → investors more wiling to invest → higher demand for AUD
o Expected that currency will depreciate in future → investors less willing to invest → lower demand for AUD
Impacts of Appreciation of AUD on Current Account
- Australian exports become more expensive in foreign terms → decrease international competitiveness → decrease exports → decrease credits in BOMT / NS → deterioration in current account
- Imports become less expensive in Australian terms → increase debits in BOMT / NS → deterioration in current account
- Makes purchase of Australian shares and other assets less attractive to foreign residents → decrease debits in Net Primary Income → improvement in current account
- Makes purchase of foreign shares and other assets more attractive to Australian residents → increase credits in Net Primary Income → improvement in current account
- Debt in foreign currencies will require less AUD to service → decrease debits in Net Primary Income → improvement in current account
Impacts of Depreciation of AUD on Current Account
- Australian exports become less expensive in foreign terms → increase international competitiveness → increase exports → increase credits in BOMT / NS → improvement in current account
- Imports become more expensive in Australian terms → decrease debits in BOMT / NS → improvement in current account
- Makes purchase of Australian shares and other assets more attractive to foreign residents → increase debits in Net Primary Income → deterioration in current account
- Makes purchase of foreign shares and other assets less attractive to Australian residents → decrease credits in Net Primary Income → deterioration in current account
- Debt in foreign currencies will require more AUD to service → increase debits in Net Primary Income → deterioration in current account
Impact of Exchange Rates on Goal of Strong and Sustainable Growth
- Appreciation of AUD:
o Demand side: Reduced international competitiveness → decreased exports → decreased aggregate demand → decreased economic activity → decreased growth
o Supply side: Decreased cost of imports → decreased cost of production → increased production and growth - Depreciation of AUD:
o Demand side: Increased international competitiveness → increased exports → increased aggregate demand → increased economic activity → increased growth
o Supply side: Increased cost of imports → increased cost of production → decreased production and growth
Impact of Exchange Rates on Goal of Full Employment
- Appreciation of AUD: Decreased international competitiveness → decreased exports → decreased aggregate demand → decreased economic activity → decreased derived demand for labour → decreased employment
- Depreciation of AUD: Increased international competitiveness → increased exports → increased aggregate demand → increased economic activity → increased derived demand for labour → increased employment
Impact of Exchange Rates on Goal of Low Inflation
- Appreciation of AUD:
o Demand side: Reduced international competitiveness → decreased exports → decreased aggregate demand → moves economy away from productive capacity → decreased demand inflationary pressures
o Supply side: Decreased cost of imports → decreased cost of production → increased productive capacity → decreased cost inflationary pressures - Depreciation of AUD:
o Demand side: Increased international competitiveness → increased exports → increased aggregate demand → moves economy closer to productive capacity → increased demand inflationary pressures
o Supply side: Increased cost of imports → increased cost of production → decreased productive capacity → increased cost inflationary pressures
Impacts of Exchange Rates on Living Standards
- Appreciation of AUD
o Decreased employment → decreased access to goods and services and higher crime rates
o Decreased employment → increased financial stress levels
o Decreased inflationary pressures → increased access to goods and services - Depreciation of AUD
o Increased employment → increased access to goods and services and lower crime rates
o Increased employment → decreased financial stress levels
o Increased inflationary pressures → decreased access to goods and services
International Competitiveness
- Measures a country’s ability to compete in global markets for goods and services on price
Factors Affecting International Competitiveness
- Productivity – output per unit of input
o Increased productivity → increased international competitiveness
o Decreased productivity → decreased international competitiveness - Production Cost – cost of labour, capital and raw materials
o Increased production cost → decreased international competitiveness
o Decreased production cost → increased international competitiveness - Availability of Natural Resources
o Increased availability → increased ability to produce → increased international competitiveness
o Decreased availability → decreased ability to produce → decreased international competitiveness - Exchange Rates
o Appreciation of AUD → increased cost of Australian goods and services in foreign terms → decreased international competitiveness
o Depreciation of AUD → decreased cost of Australian goods and services in foreign terms → increased international competitiveness - Relative Rates of Inflation
o Lower relative rates of inflation → increased international competitiveness
o Higher relative rates of inflation → decreased international competitiveness
Impact of International Competitiveness on Goal of Strong and Sustainable Growth
- Increased international competitiveness → increased exports → increased aggregate demand → increased production → increased economic growth
- Decreased international competitiveness → decreased exports → decreased aggregate demand → decreased production → decreased economic growth
Impact of International Competitiveness on Goal of Full Employment
- Increased international competitiveness → increased exports → increased aggregate demand → increased production → increased derived demand for labour → increased employment
- Decreased international competitiveness → decreased exports → decreased aggregate demand → decreased production → decreased derived demand for labour → decreased employment
Impact of International Competitiveness on Goal of Low Inflation
- Increased international competitiveness → increased exports → increased aggregate demand → increased production → moves economy closer to productive capacity → increased demand inflationary pressures
- Decreased international competitiveness → decreased exports → decreased aggregate demand → decreased production → moved economy away from productive capacity → decreased demand inflationary pressures
Impact of Net Foreign Debt on Current Account
o Increased NFD → decreased Net Primary Incomes due to higher interest repayments → deterioration in current account
o Decreased NFD → increased Net Primary Incomes due to lower interest repayments → improvement in current account
Impact of Net Foreign Equity on Current Account
o Increased NFE → increased Net Primary Incomes due to higher dividends/profits → improvement in current account
o Decreased NFE → decreased Net Primary Incomes due to lower dividends/profits → deterioration in current account
Reason for Expected Current Account deterioration
Increased global interest rates → increased debits in Net Primary Incomes
Current Account balance…
- Current Account Surplus
- Current Account Deficit
Net Foreign Debt and Exchange Rate
- Appreciation of AUD → more able to service existing debt levels → reduced net foreign debt
- Depreciation of AUD → less able to service existing debt levels → increased net foreign debt
Supply of AUD
Money leaving Australia
Purchase of imports → increase supply of AUD
Point of Difference between Net Foreign Debt and Net Foreign Equities
Borrowing and lending VS ownership of assets
Impact of Change in Exchange Rate on Terms of Trade
- DIRECT impact (price)
- Appreciation → imports less expensive and exports more expensive → improve terms of trade
- Depreciation → imports more expensive and exports less expensive → deteriorate terms of trade
Relationship between Current Account and Capital and Financial Account
- Must equal zero
- CAFA transactions create opposite future impact on CA
