chapter 14 Flashcards
The weakness of the Australian dollar during the 1980s and 1990s compared to the currencies of its major sources of overseas students, such as Singapore and Malaysia,
contributed to maintaining Australia’s competitiveness relative to its major competitors, the United States and the United Kingdom, against whose currencies the Australian dollar also depreciated.
In the 2000s the emerging mega-markets of India and China provided
huge opportunities for Australian educational institutions. In 2013, China and India were the largest and second largest, respectively
when did the $AU apprecitate? what happened?
Between January 2010 and February 2012, $AU appreciated significantly
cost of studying increased relative to competitors such as UK and US
open and closed economy
open economy: An economy that has interactions in trade or finance with other economies.
closed economy: An economy that has no interactions in trade or finance with other economies. (very few such as North Korea)
3 accounts in BOP
- Current account
- capital account
- financial account
what is the current account
Records current, or short- term, flows of funds into and out of a country.
Current account includes
net exports
net primary income
net secondary income
what is net exports/ balance of goods and services?
The difference between the value of the goods and services a country exports, and the value of the goods
and services a country imports.
how can you explain the huge trade deficit experienced between 2003 and 2008.
- nationwide drought –> fall in agricultural export earnings
- resource boom and strong economic growth –> increase in imports
When did BOGS move into a surplus?
why?
In 2009 and again in 2011
b/c
- droughts ended. agricultural exports recovered
- increase in export earnings from resource sector
what happened to BOGS from 2012 onwards?
Moved back into deficit due to fall in commodity prices
trend of Australia’s net primary income
has consistently been in deficit
net primary income includes
income received by Australian residents from investments in other countries including profits, dividends, rental income and interest repayments on foreign borrowing from Australia, minus income paid to overseas residents from investments in Australia.
Income into australia (credits)
Income going overseas (debits)
why has net primary income consistently been in a deficit?
low domestic savings –> insufficient funds borrowed for investment and gov expenditure–> firms and gov borrow from overseas to finance investment and spending
since firms and govs borrow from overseas, what does this mean for net primary income?
large component of net primary income are interest payments on foreign loans
describe why Australia is a net recipient of foreign investments
Foreign financial institutions, corporations and individuals buy bonds, securities and shares in Australia, and also own many businesses in Australia.
The outflow of profits and dividends usually exceeds the inflow that Australian residents receive from overseas investments,
describe trend of Australia’s net primary income account
began to grow during the second half of the 1980s, with the deficit accelerating in the 2000s.
From the early 1990s to 2007 the continual period of strong economic growth led to increased levels of domestic borrowing, largely for investment, together with increased foreign investment –> increased interest repayments and repatriation of profits and dividends
what happened to net primary income account during the GFC?
fall in the deficit on net primary income, as the sum of the returns on shares and interest earnings flowing out to overseas investors fell.
describe capital account
The part of the balance
of payments that records migrants’ asset transfers(assets people take with them when they leave or enter a country), debt forgiveness and sales and purchases of non- produced, non-financial assets (intellectual property)
The financial account records
purchases of physical assets and financial assets that a country has made abroad and foreign purchases of physical and financial assets in the country
what is foreign direct investment
When firms build or buy facilities in foreign countries e.g. Australian firm buys a factory in another country
what is portfolio investment
When investors buy shares, bonds or securities issued in another country
Another way of thinking of the balance on the financial account is as a measure of
net capital flows, or the difference between capital inflows and capital outflows
A closely related concept to net capital flows is
net foreign investment, which is equal to capital outflows minus capital inflows.
relationship between net capital flows and net foreign investment
Net capital flows and net foreign investment are always equal but have opposite signs i.e. when net capital flows are positive net foreign investment is negative, vice versa
e.g. If more is being invested by Australians abroad than the amount of foreign investment flowing into Australia, Australia’s net foreign investment is positive. vice versa
Net foreign investment is also equal to
net foreign direct investment plus net foreign portfolio investment
Why is the balance of payments always zero?
balance on the current account must equal to the balance on capital and financial accounts
Current account deficit offset by capital and financial account surplus
a net errors and omissions is included in BOP to ensure it is balance
In 2012/13 Australia spent nearly $55 billion more on goods, services, interest repayments and other items in the current account than it received. What happened to that $55 billion?
every dollar of that $55 billion was used by foreign individuals or firms to invest in Australia, or was added to foreign holdings of Australian dollars.
can’t have been spent on on Australian goods and services or interest repayments, they must have been spent on investments in Australia or not spent at all- added to foreign holdings of dollars.
The industrial countries are committing economic suicide. Every year they invest more and more in developing countries. Every year more Japanese and US manufacturing firms move their factories to developing countries. With extensive new factories and low wages, developing countries now export far more to the industrial countries than they import.’
critique this
The commentator asserts that developing countries are receiving large capital inflows from industrial countries. In other words, developing countries are running financial account surpluses.
The commentator also asserts that developing countries are exporting more than they are importing. In other words, they are running current account surpluses.
it is impossible to run a current account surplus and a financial account surplus simultaneously.
Nominal exchange rate
The value of one country’s currency in terms of another country’s currency.
Banks and other financial institutions around the world employ currency traders, who are linked together by computers. Rather than exchanging large amounts of paper currency,
they buy and sell deposits in banks.
A bank buying or selling Australian dollars will actually be buying or selling Australian dollar bank deposits.
There are three sources of foreign currency demand for the Australian dollar:
1 Foreign firms and consumers that want to buy goods and services produced in Australia.
2 Foreign firms and consumers that want to invest in Australia either through foreign direct investment or foreign portfolio investment
- speculators who believe $AU will appreciate
draw the foreign exchange market
Surpluses and shortages in the foreign exchange market are eliminated very quickly because
the volume of trading in major currencies such as the dollar and the yen is large and currency traders are linked together via computers.
3 factors that influence a shift in demand and supply curves in the FOREX market
- Changes foreign demand for Asutralian exports and changes in Australian demand for imports
- Changes in the desire to invest in Australia and changes in the desire of Australian firms and individuals to invest in foreign countries.
3 Changes speculators’ expectations
Shifts in the demand for foreign exchange
what can influence a change in desire to invest in Australia?
if interest rates in Australia rise, and are higher relative to interest rates in other countries, the desirability of investing in Australian financial assets will increase, and the demand curve for dollars will also shift to the right
define speculators
Speculators buy and sell foreign exchange in an attempt to profit from changes in exchange rates.
what can cause a change in demand on exports and imports?
economic growth of Australia and foreign countries
explain what causes shift in suppy for $AU?
- Australia economic growth rises –> increase income –> increase goods and services –> increase in imports –> sell $AU –> supply shifts
- Interest rate overseas is higher –> invest in overseas assets –> sell $AU
- Speculators expect $AU to depreciate –> sell $AU
Australia’s exchange rate, however, some currencies have fixed exchange rates
describe
fixed exchange rates that do not change over long periods.
e.g. for over 10 years the value of the Chinese yuan (renminbi) was fixed against the US dollar at a rate of 8.28 yuan to the US dollar
what affect would an appreciation and depreciation have on the economy
appreciation = reduce export income + increase imports, reducing net export income –> decrease AD and real GDP
depreciation= increase export income and decrease imports, thereby increasing net export income –> increase AD and real GDP
how to calculate the real exchange rate
real exchange rate = nominal exchange rate x (domestic price level/ foreign price level)
when may a country experience a financial account surplus?
When a country sells more assets to foreigners than it buys assets from foreigners, or borrows more from foreigners than it lends to foreigners
if it is running a current account deficit—the country experiences a net capital inflow
net exports + net primary income =
net foreign investment
If the current account is in deficit,
net foreign investment must be negative by the same amount
foreign investment into Australia must exceed Australian investment abroad by the amount of the current account deficit.
Formula for private saving
PUblic saving =
Government saving = taxes – government spending
SPublic = T - G
what are components of GNI
GNI = GDP (C+I+G+NX) + NPI (income from overseas profit, dividends, interest)
what is the saving and investment equation
National saving = domestic investment + net foreign investment
S = I + NFI
The saving and investment equation tells us that
a country’s saving will be invested either domestically or overseas
e.g. If you save $1000 and use the funds to buy a bond issued by BHP Billiton, BHP Billiton may use the $1000 to renovate a factory in Australia (I) or to build a factory in China (NFI ) as a joint venture with a Chinese firm.
what does S – I = NFI
show
Australia that has negative net foreign investment must be saving less than it is investing domestically.
domestic investment > national saving.
Japan has high savings
what does that mean
national savings in Japan > domestic investment –> high levels of jap net foreign investment
e.g. Japanese company Sony owns the Columbia Pictures film studio in the United States.
due to low domestic saving levels, what does Japan do?
Japan needs a high level of net exports to help offset a low level of domestic investment.
When exports of a product begin to decline and imports begin to increase, governments are very tempted to impose tariffs or quotas to reduce imports.
In fact, many Japanese firms have been urging the Japanese government to impose trade restrictions on imports from China
f the federal government runs a budget deficit the Australian Treasury
if the federal government runs a budget deficit the Australian Treasury must raise an amount equal to the deficit by selling government bonds and securities.
Some of these securities will be purchased by Australians but the majority will be sold on international financial markets.
To purchase bonds in Australia, overseas investors have to?
how does this affect the Australian economy?
buy $AU to purchase Australian bonds –> increase in demand for $AU –> $AU appreciates –> net export falls –> net foreign investment falls
describe twin deficit hypothesis
When a government budget deficit leads to a decline in net exports –> CAD
Discuss a budget deficit and twin deficit theory in terms of the saving and investment equation
The saving and investment equation shows that an increase in the government budget deficit will not lead to an increase in the current account deficit provided either private saving increases or domestic investment declines.
why was the twin deficits theory discussed widely from mid 70s to 80s?
qhen the federal government ran large budget deficits that resulted in
high interest rates
a high exchange value of the dollar
large current account deficits.
the link between a government budget deficit and a current account deficit assumes
that other factors affecting the current account remain the same
he link between a government budget deficit and a current account deficit assumes that other factors affecting the current account remain the same, which they do not. For example,
, from the late 1990s to 2007, the government operated budget surpluses and the current account deficit increased even more.
there was an increase in national saving from budget surpluses but this was offset by a sharp decline in private saving, and Australia ran very large current account deficits.
australia’s CAD result largely from
what does this mean
Australian net foreign investment being negative. largely from deficit in net primary income
Australia has either borrowed from the rest of the world or foreigners have purchased Australian assets.
By 2013 total foreign investment in Australia was
Australian investment abroad totalled
2013 total foreign investment in Australia was $2345.3 billion, while Australian investment abroad totalled $1533.3 billion.
Total net foreign liability is
net foreign debt liabilities + net foreign equity liabilities
Net foreign debt
difference between the amount Australia lends to other countries and the amount Australia borrows from overseas
Net foreign equity liability refers to
foreign ownership of Australian assets such as shares in a company minus Australian ownership of foreign assets.
describe trend of australia’s net foreign liabilities and debt as a proportion of GDP
rising significantly over time due to the government relaxing capital controls on private sector borrowing and foreign purchases of Australian assets, together with the effect of the floating of the dollar
by 2013 net foreign debt comprised around
by 2013 net foreign debt comprised around 98 per cent of total net foreign liabilities and has risen significantly over time
describe trend of net foreign debt
1970s = less than 5% of GDP
2006-2013 = 49-52% of GDP
trend of net foreign liabitlies
Total net foreign liabilities have risen from 10 per cent in the mid-1970s to a high of 58 per cent in 2010, before declining somewhat to 53 per cent by 2013.
low savings (small population) in Australia means?
Australia needs to borrow from overseas to maintain high levels of domestic investment for economic growth
The largest proportion of net foreign debt in Australia
but
private debt
but since 2008 federal government debt has been increasing, representing around 26 per cent of net foreign debt by 2013.
since most of net foreign debt is comprised of private debt, what does this mean for the economy?
If the private sector is borrowing for investment purposes –> expands Australia’s capital stock –> future profits rise –> debts can be serviced
discuss debt as a problem in developing countries
debt service burdens are so high (much of which is government debt) that it places a huge burden on national income.
Borrowing then occurs simply to make the interest repayments, with no additional means of making repayments being generated, causing these countries to spiral into ever rising debt.
debt forgiveness initiative
what is it
by wealthier countries, which began as a joint initiative in the mid-1990s, is seen as an important step in addressing the enormous debts and poverty of developing countries
what are indicators that australia’s high net foreign debt and net foreign liabilities is not a problem
The continued willingness of foreign investors to lend to Australia and buy Australian shares and bonds, and foreign companies to build factories in Australia
Monetary policy in a closed economy
main effect is on domestic investment spending and purchases of consumer durables
Monetary policy in an open economy
contractionary
higher interest rate –> increased investment in AU assets –> $AU appreciates –> export revenue falls and imports rise –> net export falls –> aggregate demand falls
so it will be more effective in slowing down the growth in economic activity.
Monetary policy in an open economy
higher interest rate –> increased investment in AU assets –> $AU appreciates –> export revenue falls and imports rise –> net export falls –> aggregate demand falls
so it will be more effective in slowing down the growth in economic activity.
expansionary monetary policy in an open economy
lower interest rate –> some investors in Australia will invest overseas financial assets –> supply $AU increases –> $AU depreciates –> increase export revenue and reduce impors –> net exports falls –> aggregate demand rises
in summary, monetary policy in an open economy?
monetary policy has a greater impact on aggregate demand in an open economy than in a closed economy.
fiscal policy in an open economy
expansionary fiscal policy (a government budget deficit) may result in higher interest rate what impact does this have on an open economy?
higher interest rate –> fall in net exports
expansionary fiscal policy may be less effective since the decrease in net exports will reduce the rate of increase of aggregate demand.
fiscal policy in an open economy
expansionary fiscal policy (a government budget deficit) may result in higher interest rate
BUT what if the government finances its deficits by borrowing on international financial markets instead of domestic markets?
no effect on interest rate b/c according to the loanable funds model, it is not reducing domestic savings pool
but the inflow of foreign capital will cause the demand for the Australian dollar to rise, leading to an appreciation of the dollar, reducing net exports
fiscal policy in a closed economy
In a closed economy only consumption and investment are crowded out by an expansionary fiscal policy – > reduced savings
contractionary fiscal policy in a closed economy
lowers interest rate
Lower interest rates will increase domestic investment and purchases of consumer durables, thereby offsetting some of the reduction in government spending and increase in taxes
contractionary fiscal policy in a closed economy
if the government reduces its deficits there will be a reduced need for borrowing from overseas, and therefore less demand for the Australian dollar.
Therefore, in an open economy a contractionary fiscal policy will have
a smaller impact on aggregate demand and thus will be less effective in slowing down an economy.
