Topic 2 - Australia's Place in the Global Economy

Question 1

Outline and Explain the 4 factors that affect the SIZE and COMPOSITION of Australia’s Balance of Payments.

Answer 1

1) International Competitiveness (Structural) - Australia lacks IC from a narrow export base/expensive value-added imports + volatile interest rates.
2) Terms of Trade (Cyclical) - Increasing from Export/Import prices and an appreciation of agriculture and mineral exports.
3) International Borrowing (Structural) - Savings-Investment Gap + High Debt-servicing costs
4) Foreign Investment (Cyclical) - Net Foreign Liabilities (FE + FD) + E/R movements

Question 2

State the composition of Australia’s Trade [Exports (G&S) + Imports]

Answer 2

Exports: Top 3 Goods - Coal, Iron, LNG
Top 3 Services - Education, Tourism, Transport
- Valued at $457bn in 2021

Imports: Secondary & High value-added Goods (Clothing, Vehicles, Machinery)
- Valued at $400bn in 2021

Question 3

State the direction of Australia’s Trade between overseas Economies

Answer 3

Since the 1970s, Australia’s exports have transitioned away from EU countries (U.K) to Asia-orientated (APEC)
- China takes in roughly 1/3 of Australian exports.

However, imports are more diversified between Asia, the EU and U.K, with China only taking 22%.

Question 4

State the 2 benefits and 2 costs of FDI & TNCs entering the Australia Economy.

Answer 4

Advantages: 1) Fund economic growth/integration with global forex and trade markets.
2) Attracting TNCs –> Job creation + cheaper and new technology.

Disadvantages: 1) Lower production and market share of domestic firms.
2) Volatile nature of capital outflows and forex rates, leading to LT NPY deficit.

Question 5

List and define all the components under the Current Account (Non-reversible).

Optional: State the surplus/deficit of each account.

Answer 5

Balance of Goods and Services (BOGS) = Net Goods + Net Services - ($89bn surplus 2021)

Trade Balance = Net Primary Income (Factors of production) + Net Secondary Income (Unconditional transfers).
- NPY is commonly in deficit. ($18.8bn in 2021)

Question 6

List and define all the components under the Capital and Financial Account (Reversible).

Answer 6

KA: 1) Net Acquisitions/Disposals = Purchase/Sale of non-produced, non-financial assets such as trademarks, franchises, etc.
2) Capital transfers = Conditional foreign aid grants and debt forgiveness to overseas countries.

FA: 1) Direct Investment 2) Portfolio Investment

3) Financial Derivatives = Assets, Forex rates, market hedges
4) Reserve Assets = Foreign assets controlled by RBA.
5) Other Investments = Covers loans, currency, deposits, etc.

Question 7

List the main cause (1) and effects (2) when shifting from a CAD to a CAS.

Answer 7

1) ST: Initial Depreciation of AUD (J-Curve)
2) ↓ Interest rates, but ↑ in IC
3) LT: ↑ X Revenue and hence, CAS.

Question 8

State the 2 Financial Flows that contribute to the Net Primary Income (NPY) Deficit.

Outline 1 pro + 1 con of each:

Answer 8

1) High level of International Borrowing:
Pro: Greater access to credit and capital for economic growth + Expands production.
Con: Worsens NPY deficit due to greater interest repayments and debt-servicing costs.

2) Increasing Foreign Investment:
Pro: Provides access to foreign funds and new technology, aimed to reduce S-I gap.
Con: High foreign liabilities and debt, worsening Australia’s CAS.

Question 9

State the 3 cyclical factors affecting the Balance of Payments

Answer 9

1) TOT
2) Exchange + Interest Rates - App/Dep
3) Changes in Global/Domestic Demand in IBC

Question 10

State the 3 structural factors affecting the Balance of Payments

Answer 10

1) Changes to M/X Base and Prices
2) International Competitiveness
3) Level of National Savings

Question 11

State the 4 causes for Australia’s Terms of Trade to improve.

Answer 11

1) Increase in Global Demand
2) Decrease in production costs
3) Inflation + Appreciation
4) Decrease in World Commodity Prices

Question 12

State how the Terms of Trade Index is calculated and how the TOT improves through price.
(Cyclical Factor)

Answer 12

TOT = (Export Price / Import Price) x 100

Improves = Export Prices increases faster than Import Prices.

Question 13

State the 3 benefits of an Appreciation in $AUD on the BOGS and NPY.

Answer 13

1) Cheaper imports – ↑ IC and ↓ CAD.
3) Less overseas repayments – ↓ NPY deficit, ↓ CAD
3) Reduced NPY deficit from increase in $A value

Question 14

State the current situation with Australia’s Export/Import Base.
(Narrow/Expensive)

Answer 14

Narrow Export Base: Bulk, primary commodities such as minerals and agriculture. (Over 2/3 of Export earnings). However, has extremely volatile prices.

Expensive Import Base: High value-added consumer and capital goods which holds greater payments overseas than export receipts. Hence, BOGS ends in deficit in the long term.

Question 15

State the current situation with Australia’s International Competitiveness and methods of improving it.

Hence, state the level of National savings.

Answer 15

Low IC due to narrowly exporting low value-added G&S, unable to compete against the manufacturing industry.

• Improve IC by producing high-tech., ETM’s, and exporting greater services.

Low level of national savings in the past 3 decades, but as of 2020, high national savings levels due to covid-19. (CAD —> CAS)

Question 16

List the 5 main consequences of high CAD/Foreign Debt levels.

Answer 16

1) Growth of Foreign Liabilities - Debt-Servicing Costs + Interest Repayments
2) Increased volatility of Forex rates
3) Constraint on future economic growth
4) Contractionary Government Policy - Expansionary Fiscal, Contractionary Monetary
5) Loss of international investor confidence

Question 17

List the 4 factors that improve Australia’s international competitiveness

Answer 17

1) Structural Change of Economy (Cheaper Forex/Interest rates, productivity, etc.)
2) Reduction in Australia’s TOT
3) Depreciation of $AUD
4) Lower inflation levels

Question 18

What structurally leads to a NPY deterioration in Australia’s CAD?

Answer 18

An increase in interest rates and NFL as Australia must send interest repayments from its Income Balance overseas.

Question 19

State the 3 effects of a DECREASE in TOT.

Answer 19

↑TOT = ↑ Foreign Demand for X = ↑ Appreciation of Currency = ↓ International Competitiveness

Question 20

Distinguish between Bilateral Exchange Rates and the Trade Weighted Index (TWI).

Answer 20

BER: Measures the value of a domestic currency relative to a foreign currency. (E.g.: US$ to A$)

TWI: Measures the movements of A$ against a basket of currencies, weighted according to their importance in Australia’s trade.

Question 21

Explain why Australia’s exchange rate against the US dollar might NOT move in the same direction as Australia’s Trade Weighted Index.

Answer 21

On one hand, the EU may increase demand for $A (Appreciation), while foreign economies such as APEC may reduce their demand for $A (depreciation).

The AUD will depreciate against the TWI due to Asian countries having a greater trading presence/market share than the EU, but appreciate against the EU currency due to bilateral cross rates.

Question 22

There is a downturn in a major importer of Aus. G&S, state the effect and explain it.

a. Depreciation of $AUD
b. Appreciation of $AUD
c. Revaluation of the importer’s currency
d. Devaluation of the importer’s currency

Answer 22

a. Depreciation of the $AUD

Decrease in demand for AUD, leading to a lower equilibrium from a shift to the left of the D curve.

Question 23

When Supply shifts right, which factor would demand be affected by: foreign imports/foreign assets/Aus. exports/Aus. assets

Answer 23

A supply shift to the right (Increase), would increase the demand for foreign assets by Australians.

Question 24

List the impacts when the $AUD appreciates.

Answer 24

1) ↓ Capital Inflows
2) ↑ TOT
3) ↓ Economic Growth
4) ↓ Debt, ↑ Equity
5) ↓ Inflation
6) ↓ Interest Rates

Question 25

When “Euro per $A1” increases from Y1 to Y2, but “$US per $A1” decreases from Y1 to Y2, state the effects on $AUD.

Answer 25

1) $AUD has appreciated against the Euro if foreign inflation increases.
2) $AUD has depreciated against the US if foreign inflation decreases.

Question 26

Distinguish between Floating, Fixed and Managed Exchange Rates.

Answer 26

Floating = Determined by D/S forces with NO GI.

Fixed = RBA pegs the E/R at a decided rate to block unregulated D/S forces.

Managed = Selects a target corridor for E/R, with necessary intervention to achieve it.

Question 27

List 2 Advantages for Floating, Fixed and Managed Exchange Rates.

Answer 27

Floating: 1) Insulates economy from real, external shocks such as ↓ D for Aus. X and ↓ TOT.
2) Greater capital market integration and mobility of assets.

Fixed: 1) Greater certainty for X/M’s in short-term.
2) Fixes E/R to low or high interest rates during downturns/upturns.

Managed: 1) Avoids excessive inflation/deflation scenarios.
2) Requires lower supply of reserve assets.

Question 28

List Disadvantages for Floating, Fixed and Managed Exchange Rates.

Answer 28

Floating: 1) Susceptible to E/R volatility due to ‘overshooting’.
Hence, discourages trade and investment growth from excessive depreciation and speculation.

Fixed: 1) Requires large supply of reserve assets.
2) Does not respond to financial changes/crises swiftly.

Managed: 1) Limited control over an overvalued exchange rate, drifting from pure market forces.
2) Shifts funds away from macroeconomic objectives and structural demands.

Question 29

List the 4 main factors and their movements that increase the demand and supply of $AUD.

Factor ↑/↓ –> D/S ↑/↓

Answer 29

1) Aus. M demand (↑ = ↑S for AUD)
2) World Demand for Aus. X (↑ = ↑D for AUD)
3) Domestic Interest rate differential (↓ = ↑S | ↑ = ↑ D)
4) Expected future exchange rate (↓ = ↑S | ↑ = ↑ D)

Question 30

Describe the theory of the J-Curve.

Relate it to the curve’s shape.

Answer 30

Qualitatively: Despite the AUD depreciating, leading to a BOGS deficit due to low export prices, Australia will maintain high international competitiveness and after economic conditions stabilise, the CAD improves.

Graphically: Stagnant at first, Short-term increase in CAD, but improves at an increasing rate towards a CAS.

Question 31

Explain how and why the RBA intervenes in the Exchange Rate market.

Answer 31

How: Exchanging foreign reserve assets by buying or selling $USD in exchange for $AUD. To depreciate A$, supply of $AUD ↑ by buying $USD. To appreciate, sell $USD overseas by ↑ demand for $AUD.

Why: 1) To stabilise it from past ‘overshooting’ of the currency - Greater E/R volatility that appreciates/depreciates $AUD further than necessary

2) To reduce excessive depreciation and high inflation- Limit disruptive PRICE adjustments from excessive depreciation.

Question 32

Explain the 2 methods on how the RBA could depreciate the AUD.

Answer 32

To depreciate the AUD, the RVA can either decrease the demand for AUD or increase the supply for AUD. Hence, the RBA must first SELL USD into the foreign exchange market so that supply of AUD INTERNATIONALLY increases.

From an expansionary MP, the AUD will depreciate as Interest rates fall, reducing foreign investment and IC which reduces the demand for AUD in the forex market.

Question 33

State the exact terms when calculating NFL.
(1. Loans owed by F2A. 2. Loans owed by A2F. 3. A Assets owned by F. 4. F Assets owned by A)
(Hint: A first)

Answer 33

L = E + D
L = (3 - 4) + (2 - 1) 
L = (A Assets - F Assets) + (F Loans - A Loans)

Question 34

A decline in Australia’s NFL as a % of GDP is recorded. What factor has likely increased that led to this?

Answer 34

Depreciation —> Increase in investment returns —> Higher revenue removes loans/debt-servicing costs.

Question 35

Explain how the level of national savings affects Australia’s CAD.

Answer 35

1) Low saving levels lead to higher borrowing rates to make up for high spending levels. Interest in repayments leads to higher CAD.
2) High saving levels reduce CAD due to lower import spending and reduced liabilities/debt-servicing costs.

Question 36

State Australia’s trend in financial flows through its foreign equity and debt.

Answer 36

• Australia is usually a net provider of foreign equity, with its net foreign debt being greater than net foreign equity.

Question 37

Define Aggregate Supply and state one method of increasing AS in an economy

Answer 37

Aggregate Supply refers to the total volume of G&S firms are willing to produce over time.
- Microeconomic Reform: Firm regulation increased to ensure fair competition, AS would increase as firms are producing more.