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Why The Balance Of Payments And The Current Account Deficit Are So Important.

899 words - 4 pages

Why Is the Balance of Payments and the CAD So ImportantThe balance of payments is a summary of all Australia's transactions with the rest of the world. The balance of payments may give an explanation for, as an example, why the value of the Australian dollar has appreciated. A current account deficit occurs when the current account does not balance but is negative. The reason Australia has a current account deficit is because of greater levels of debits than credits on goods, services, incomes and unrequited transfers. A CAD is also due to a greater part of our investment coming from overseas savings.Foreign investment will increase foreign debt. This may not necessarily be a bad thing as it will increase a country's productivity leading to greater technological advancements and higher levels of employment and growth. Australia is still a young country with a potential for development. The only problem is that domestic households and firms are never likely to save enough to finance all the investment our country needs. Australia has always been a capital-importing country. This surplus on the capital account of the balance of payments has always caused Australia to run a deficit on the current account.The balance of payments may give reasons for economic occurrences. As an example, if the Australian Dollar falls in value, the balance of payments may give an answer for why it has happened. This enables the Reserve Bank of Australia to manage this macroeconomic objective of external balance by using reserve assets of other currencies to influence the FOREX market.The strong domestic economy, the drought and the weak global economy explain why the CAD is now so high. Recent blowouts in the balance of trade in goods and services are the main cause of the CAD's highs. By far the biggest part of the CAD is the net income deficit. The CAD follows the business cycle. Australia's high marginal propensity to import is clearly shown during a boom as imports greatly increase and decrease during a recession. This also applies to investment as there is more during high times of certainty but during a recession firms may disinvest. The government can then decide how to manage the economy based on the information received. The Reserve Bank of Australia can decide to slow the economy down through forces of contractionary monetary policy in the cash rate and local interest rates. The problem with high interest rates is that it encourages international firms to invest in Australia, due to the result of a higher return.The balance of payments may indicate the economy is nearing a recession. It is important managing the economy because of this...

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