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1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

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BP and external stability

External instability means that a country becomes unable to meet its financial obligations that stem from transactions with other countries.  It typically manifests itself in the form of a very high and unsustainable level for the current account deficit (CAD) and increasingly unsustainable levels for Net Foreign Debt (NFD).  This occurs because national spending by all Australians (both public and private sectors) exceeds national income (production).  The government recognises that to achieve external stability (or reduce pressure on the CAD/NFD) we must:

  1. Save more (or spend less);  and/or
  2. Increase Australia's share of world income (e.g. by increasing export income).

Remember that part of the government's fiscal strategy is designed to improve the government's net financial worth over the medium term.  The government's budgetary policy strategy is generally to keep public sector debt to low levels and ensure that the current account reflects private saving and investment decisions.  This is one rationale for the current government's commitment to fiscal consolidation (i.e. returning the budget to surplus and achieving budget surplus on average over the course of the cycle).  This will help to ensure that the government does not contribute to the national imbalance between Savings and Investment (or insufficient savings) by unnecessarily allowing the budget to move into deficit territory.  A deficit is likely to add to external pressures because the government spends more than it earns (i.e. becomes a dissaver) and adds to national net debt levels.

Note that the problems with excessive spending relative to income, and unsustainable debt levels that result, are highlighted by the economic predicament facing European countries like Greece. With the country spending beyond its means for many years (fuelled by an inefficient public sector), national debt levels became unsustainable, creating what became known as the 'Greek Financial Crisis.' Greece's credit rating plummeted to CCC and the future cost of debt will be significantly higher in order to account for the added risk, which impacts negatively on future rates of growth for Greece.

While the size of Australia's CAD has fallen over the past couple of years, the generally high levels for Australia's CAD and NFD is generally considered to be a structural feature of a growing and thriving economy.  Indeed, efforts by the government to use budgetary (and monetary) policies to reduce the size of the CAD/NFD have largely been unsuccessful over recent decades.  During the late 1980's and 1990's, many policy makers were of the view that by reducing the budget deficit we could reduce the CAD.  In reality, this did not occur simply because the private sector Savings and Investment imbalance actually widened in response to increase public sector savings (i.e. the private sector net borrowing actually increased).  

Specific budgetary policy initiatives that can assist by boosting national savings or Australia's net export income include the following:

These types of measures could ease CAD/NFD pressures by reducing the gap that exists between national spending and national income.  With those measures to boost savings, it results in less spending (GNE), whilst measures to boost net exports work to boost national income - both working to reduce the spending/income imbalance (which is the same as the Savings/Investment imbalance).

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