External imbalance : the Australian solution

McAvoy, Joanne. (1987). External imbalance : the Australian solution Honours Thesis, School of Economics, The University of Queensland.

       
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Author McAvoy, Joanne.
Thesis Title External imbalance : the Australian solution
School, Centre or Institute School of Economics
Institution The University of Queensland
Publication date 1987
Thesis type Honours Thesis
Total pages 111
Language eng
Subjects 14 Economics
Formatted abstract This study investigates the fundamental causes underlying Australia's persistent current account deficits. External imbalance is the broad terminology by which these deficits will be defined. It is conducted against a back-drop of a survey of relevant literature. A detailed investigation of the exchange rate effects between Australia and its major trading partner Japan is case- studied in the context of the main empirical investigation. The main empirical contribution lies in the stochastic modelling of exogenous and endogenous shocks. Using a Walrasian general equilibrium approach, it can be argued that the market for non- traded goods in Australia is the "culprit" of its external imbalance. This finding is validated by the empirical results of econometric modelling of Australia's current account overtime. ''The terms of reference" approach used in the study defines exogenous variables as: 1) changes in the terms of trade; 2) interest rate shocks; 3) retardation of world trade growth; and the endogenous variables as: 1) the burden of accumulated debt; 2) fixed investment cuts; 3) domestic output contraction; 4) export deepening and 5) import replacement. Using quarterly time series data from 1960 to 1986, behaviour of these factors and their impacts on the current account deficit are examined in depth.

This study finds a significant causal-link between the widening deficits and the surge of imports associated with domestic output expansion and increased fixed investment Such findings challenge the applicability of existing balance of payments and exchange rate theory to the Australian economy. Restoration of external balance is not solely brought about by movements in the exchange rate. One must look at the underlying cause of the excess demand or supply of foreign exchange. In the short-run, the relationship between fiscal policy and the current account deficits is far too complex forfiscal restraint to be used as a general policy prescription for fine-tuning aggregate demand. It may conceivably worsen the external imbalance. Monetary control over interest rates is feasible, but limited in its effect by the extent to which it is offset by private capital inflow. Therefore, in conjunction with its current use of monetary policy, the government must adopt a long-term fundamental committment to reduce the volume of imports by reforming Australia's industry structure. Only then will the exchange rate bring about the necessary import replacement.


 
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