chapter 14

Question 1

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,

Answer 1

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.

Question 2

In the 2000s the emerging mega-markets of India and China provided

Answer 2

huge opportunities for Australian educational institutions. In 2013, China and India were the largest and second largest, respectively

Question 3

when did the $AU apprecitate? what happened?

Answer 3

Between January 2010 and February 2012, $AU appreciated significantly

cost of studying increased relative to competitors such as UK and US

Question 4

open and closed economy

Answer 4

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)

Question 5

3 accounts in BOP

Answer 5

1. Current account
2. capital account
3. financial account

Question 6

what is the current account

Answer 6

Records current, or short- term, flows of funds into and out of a country.

Question 7

Current account includes

Answer 7

net exports

net primary income

net secondary income

Question 8

what is net exports/ balance of goods and services?

Answer 8

The difference between the value of the goods and services a country exports, and the value of the goods

and services a country imports.

Question 9

how can you explain the huge trade deficit experienced between 2003 and 2008.

Answer 9

1. nationwide drought –> fall in agricultural export earnings
2. resource boom and strong economic growth –> increase in imports

Question 10

When did BOGS move into a surplus?

why?

Answer 10

In 2009 and again in 2011

b/c

• droughts ended. agricultural exports recovered
• increase in export earnings from resource sector

Question 11

what happened to BOGS from 2012 onwards?

Answer 11

Moved back into deficit due to fall in commodity prices

Question 12

trend of Australia’s net primary income

Answer 12

has consistently been in deficit

Question 13

net primary income includes

Answer 13

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)

Question 14

why has net primary income consistently been in a deficit?

Answer 14

low domestic savings –> insufficient funds borrowed for investment and gov expenditure–> firms and gov borrow from overseas to finance investment and spending

Question 15

since firms and govs borrow from overseas, what does this mean for net primary income?

Answer 15

large component of net primary income are interest payments on foreign loans

Question 16

describe why Australia is a net recipient of foreign investments

Answer 16

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,

Question 17

describe trend of Australia’s net primary income account

Answer 17

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

Question 18

what happened to net primary income account during the GFC?

Answer 18

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.

Question 19

describe capital account

Answer 19

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)

Question 20

The financial account records

Answer 20

purchases of physical assets and financial assets that a country has made abroad and foreign purchases of physical and financial assets in the country

Question 21

what is foreign direct investment

Answer 21

When firms build or buy facilities in foreign countries e.g. Australian firm buys a factory in another country

Question 22

what is portfolio investment

Answer 22

When investors buy shares, bonds or securities issued in another country

Question 23

Another way of thinking of the balance on the financial account is as a measure of

Answer 23

net capital flows, or the difference between capital inflows and capital outflows

Question 24

A closely related concept to net capital flows is

Answer 24

net foreign investment, which is equal to capital outflows minus capital inflows.

Question 25

relationship between net capital flows and net foreign investment

Answer 25

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

Question 26

Net foreign investment is also equal to

Answer 26

net foreign direct investment plus net foreign portfolio investment

Question 27

Why is the balance of payments always zero?

Answer 27

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

Question 28

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?

Answer 28

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.**

Question 29

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

Answer 29

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.

Question 30

Nominal exchange rate

Answer 30

The value of one country’s currency in terms of another country’s currency.

Question 31

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,

Answer 31

they buy and sell deposits in banks. A bank buying or selling Australian dollars will actually be buying or selling Australian dollar bank deposits.

Question 32

There are three sources of foreign currency demand for the Australian dollar:

Answer 32

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 3. speculators who believe $AU will appreciate

Question 33

draw the foreign exchange market

Answer 33

Question 34

Surpluses and shortages in the foreign exchange market are eliminated very quickly because

Answer 34

the volume of trading in major currencies such as the dollar and the yen is large and currency traders are linked together via computers.

Question 35

3 factors that influence a shift in demand and supply curves in the FOREX market

Answer 35

1. Changes foreign demand for Asutralian exports and changes in Australian demand for imports 2. 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

Question 36

Shifts in the demand for foreign exchange what can influence a change in desire to invest in Australia?

Answer 36

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

Question 37

define speculators

Answer 37

Speculators buy and sell foreign exchange in an attempt to profit from changes in exchange rates.

Question 38

what can cause a change in demand on exports and imports?

Answer 38

economic growth of Australia and foreign countries

Question 39

explain what causes shift in suppy for $AU?

Answer 39

1. Australia economic growth rises --\> increase income --\> increase goods and services --\> increase in imports --\> sell $AU --\> supply shifts 2. Interest rate overseas is higher --\> invest in overseas assets --\> sell $AU 3. Speculators expect $AU to depreciate --\> sell $AU

Question 40

Australia's exchange rate, however, some currencies have fixed exchange rates describe

Answer 40

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

Question 41

what affect would an appreciation and depreciation have on the economy

Answer 41

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

Question 42

how to calculate the real exchange rate

Answer 42

real exchange rate = nominal exchange rate x (domestic price level/ foreign price level)

Question 43

when may a country experience a financial account surplus?

Answer 43

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

Question 44

net exports + net primary income =

Answer 44

net foreign investment

Question 45

If the current account is in deficit,

Answer 45

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.

Question 46

Formula for private saving

Answer 46

Question 47

PUblic saving =

Answer 47

Government saving = taxes – government spending S_Public = T - G

Question 48

what are components of GNI

Answer 48

GNI = GDP (C+I+G+NX) + NPI (income from overseas profit, dividends, interest)

Question 49

what is the saving and investment equation

Answer 49

National saving = domestic investment + net foreign investment S = I + NFI

Question 50

The saving and investment equation tells us that

Answer 50

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.

Question 51

what does S – I = NFI show

Answer 51

Australia that has negative net foreign investment must be saving less than it is investing domestically. domestic investment \> national saving.

Question 52

Japan has high savings what does that mean

Answer 52

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.

Question 53

due to low domestic saving levels, what does Japan do?

Answer 53

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

Question 54

f the federal government runs a budget deficit the Australian Treasury

Answer 54

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.

Question 55

To purchase bonds in Australia, overseas investors have to? how does this affect the Australian economy?

Answer 55

buy $AU to purchase Australian bonds --\> increase in demand for $AU --\> $AU appreciates --\> net export falls --\> net foreign investment falls

Question 56

describe twin deficit hypothesis

Answer 56

When a government budget deficit leads to a decline in net exports --\> CAD

Question 57

Discuss a budget deficit and twin deficit theory in terms of the saving and investment equation

Answer 57

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.

Question 58

why was the twin deficits theory discussed widely from mid 70s to 80s?

Answer 58

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.

Question 59

the link between a government budget deficit and a current account deficit assumes

Answer 59

that other factors affecting the current account remain the same

Question 60

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,

Answer 60

, 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.

Question 61

australia's CAD result largely from what does this mean

Answer 61

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.

Question 62

By 2013 total foreign investment in Australia was Australian investment abroad totalled

Answer 62

2013 total foreign investment in Australia was $2345.3 billion, while Australian investment abroad totalled $1533.3 billion.

Question 63

Total net foreign liability is

Answer 63

net foreign debt liabilities + net foreign equity liabilities

Question 64

Net foreign debt

Answer 64

difference between the amount Australia lends to other countries and the amount Australia borrows from overseas

Question 65

Net foreign equity liability refers to

Answer 65

foreign ownership of Australian assets such as shares in a company minus Australian ownership of foreign assets.

Question 66

describe trend of australia's net foreign liabilities and debt as a proportion of GDP

Answer 66

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

Question 67

by 2013 net foreign debt comprised around

Answer 67

by 2013 net foreign debt comprised around 98 per cent of total net foreign liabilities and has risen significantly over time

Question 68

describe trend of net foreign debt

Answer 68

1970s = less than 5% of GDP 2006-2013 = 49-52% of GDP

Question 69

trend of net foreign liabitlies

Answer 69

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.

Question 70

low savings (small population) in Australia means?

Answer 70

Australia needs to borrow from overseas to maintain high levels of domestic investment for economic growth

Question 71

The largest proportion of net foreign debt in Australia but

Answer 71

private debt but since 2008 federal government debt has been increasing, representing around 26 per cent of net foreign debt by 2013.

Question 72

since most of net foreign debt is comprised of private debt, what does this mean for the economy?

Answer 72

If the private sector is borrowing for investment purposes --\> expands Australia’s capital stock --\> future profits rise --\> debts can be serviced

Question 73

discuss debt as a problem in developing countries

Answer 73

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.

Question 74

debt forgiveness initiative what is it

Answer 74

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

Question 75

what are indicators that australia's high net foreign debt and net foreign liabilities is not a problem

Answer 75

The continued willingness of foreign investors to lend to Australia and buy Australian shares and bonds, and foreign companies to build factories in Australia

Question 76

Monetary policy in a closed economy

Answer 76

main effect is on domestic investment spending and purchases of consumer durables

Question 77

Monetary policy in an open economy contractionary

Answer 77

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.

Question 78

Monetary policy in an open economy

Answer 78

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.

Question 79

expansionary monetary policy in an open economy

Answer 79

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

Question 80

in summary, monetary policy in an open economy?

Answer 80

monetary policy has a greater impact on aggregate demand in an open economy than in a closed economy.

Question 81

fiscal policy in an open economy ## Footnote expansionary fiscal policy (a government budget deficit) may result in higher interest rate what impact does this have on an open economy?

Answer 81

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.

Question 82

fiscal policy in an open economy ## Footnote 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?

Answer 82

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

Question 83

fiscal policy in a closed economy

Answer 83

In a closed economy only consumption and investment are crowded out by an expansionary fiscal policy -- \> reduced savings

Question 84

contractionary fiscal policy in a closed economy

Answer 84

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

Question 85

contractionary fiscal policy in a closed economy

Answer 85

if the government reduces its deficits there will be a reduced need for borrowing from overseas, and therefore less demand for the Australian dollar.

Question 86

Therefore, in an open economy a contractionary fiscal policy will have

Answer 86

a smaller impact on aggregate demand and thus will be less effective in slowing down an economy.