External Stability

Topics: Macroeconomics, Foreign exchange market, Investment Pages: 4 (966 words) Published: April 19, 2011
External Stability

External stability is the government objective that seeks to achieve current account sustainability, a continued capacity to service foreign liabilities, and a foreign exchange rate; all of which are necessary to facilitate and encourage economic transactions between Australia and the rest of the world.

External stability is the aim of government policy that seeks to promote stability and sustainability in Australia’s external sector so that Australia can service its foreign liabilities in the medium to long run and avoid currency volatility. There are three main components to external stability: 1. A sustainable current account deficit (CAD)

2. A serviceable level of foreign liabilities
3. A stable exchange rate

Australia’s Current Account Deficit

When measuring the sustainability of a nation’s CAD, economists tend to discuss the size of the CAD as a percentage of GDP. The reason for this is that due to differences in the size of economies, looking at a the dollar value of a CAD may not provide an accurate indication of the sustainability of that CAD. Therefore by stating the value of the CAD as a percentage of GDP economists are able to make comparisons between different CAD’s.

Past experience suggest that a manageable CAD for the Australian economy is between 3-6 per cent of GDP. However the IMF recommends that the upper limit for CAD sustainability in industrialised nations to be 4 per cent in the long term. Australia’s CAD tends to average around this figure – averaging at 4.5 per cent of GDP over the past two decades, however it will foten exceed that amount in the short term when cyclical fluctuations in the balance on goods and services cause a CAD blowout.

A major underlying cause of Australia’s persistent CAD is our low level of national savings. Because domestic savings are so low, investors are forced to borrow from overseas to fund domestic investment, leading to a large capital and financial account...
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