External Stability

Question 1

What is external stability?

Answer 1

The ability of a country to service its net foreign liabilities.

Question 2

What are 6 indicators of an economy’s external stability?

Answer 2

Current Account (% of GDP)
Net foreign debt (% of GDP)
Net foreign liabilities (% of GDP)
Terms of trade
Exchange rate
International competitiveness

Question 3

What are 2 main trends in Australia’s international competitiveness?

Answer 3

1 - Depreciation of the AUD has reduced cost of exports

2 - Aside from changes in the AUD, IC has been steady around the OECD average, but transport and internet infrastructure are a drag on productivity

Question 4

Why are a country’s current account and net foreign liabilities measured as a percentage of GDP?

Answer 4

An economy with bigger GDP will find it easier to repay liabilities than a smaller economy.

So rather than measuring CA or NFL in dollars, it should be measured relative to the size of the economy.

Question 5

Why is a high level of net foreign liabilities considered a risk for an economy?

Answer 5

1. Debt-accumulation cycle
2. Higher interest rates
3. Exposure to loss of investor confidence
4. Exposure to a balance of payments crisis
5. Balance of payments of constraint

Question 6

What are 5 policies to improve a country’s external stability?

Answer 6

1. Floating the exchange rate
2. Fiscal policy
3. Compulsory superannuation
4. Microeconomic reform
5. Bank Guarantee Scheme

Question 7

How does a floating exchange rate help to improve external stability?

Answer 7

It absorbs changes in global demand

E.g. a fall in exports or foreign investment will lead to a depreciation of the AUD, which will reduce the extent to which exports and foreign investment falls

Question 8

How can fiscal policy be used to improve external stability?

Answer 8

A budget surplus can help for two reasons:

1) Avoiding budget deficits can avoid the need to borrow from overseas, and budget surpluses can be used to repay existing government debt. This can reduce the government’s debt to foreigners, which reduces the economy’s total foreign debt.
2) Contractionary fiscal policy slows growth, which will reduce demand for imports, improving the BOGS

Question 9

How does compulsory superannuation help to improve external stability?

Answer 9

Requiring individuals to save creates funds that are invested into shares. This:

a) reduces the need for foreign investment (closing the savings-investment gap), improving NFE
b) creates funds that can be used to buy shares overseas, improving NFE

Question 10

What is the level of compulsory superannuation in Australia?

Answer 10

It is increasing to 11.5% of a person’s wage in 2024, and will increase to 12% in 2025

Question 11

How does microeconomic reform help to improve external stability?

Answer 11

Improving the efficiency of Australian industries will increase international competitiveness and exports, improving the BOGS

Question 12

How does monetary policy affect a country’s external stability?

Answer 12

It has a mixed effect:

• An expansionary monetary policy would lead to a depreciation of the AUD, improving the BOGS (but potentially worsening NPY if foreign debt is denominated in foreign currencies)
• Lower local interest rates would also reduce interest costs on some foreign debt, improving NPY
• But an expansionary monetary policy would increase economic growth, which would lead to increased demand for imports and worsen the BOGS