Having higher net foreign liabilities and current account deficit, forces the government to borrow from overseas, which may lead to the “debt-trap-scenario”, since high deficits requires inflow of foreign funds contributing to larger foreign debt, which needs to be serviced; requiring to borrow from overseas and so on. However, having high foreign liabilities and CAD might reduce confidence of international markets. Firstly, this would make it difficult for Australia to borrow funds, which may force the government to “crowd-out” its domestic savings; reducing domestic investments, worsening its economy. Secondly, international credit rating would decrease, leading to higher interest rates for borrowings, thus worsening the CAD. Having an appreciation in its A$ might explain its worsened CAD. First of all, an appreciation rises price of its exports on world markets and thus reducing global demand for its exports; resulting in less export income on the current account. In addition, imports are less expensive, which encourages import spending, hence increase outflow in the current account. These two situations combined would produce a higher CAD.
Policies
As economic growth is expecting to grow and unemployment to fall, hence it could increase demand-pull as well as cost-push inflation. This occurs, since economic activity increases, hence workload increases as well. As a consequence, employees might demonstrate for higher wages. Higher wages means higher cost-push inflation and higher demand for goods and services, resulting in raising demand-pull inflation. Thus, the government might implement a contractionary fiscal policy by increasing government expenditure and/or decrease government expenditure. This would reduce aggregate demand and thus economic activity and inflation. Nevertheless, the RBA might reduce economic growth by increasing interest rates through setting a high short run cash rate. This will be achieved by implementing a tightening monetary policy stance, where the RBA sells government securities, thus reducing amount of borrowable funds, hence cash rate and market interest rates rises. Higher interest rates discourage spending, since cost of borrowing would rise and encourage saving, since increasing their money; contributing to a lower economic activity.
A lower economic activity means lower disposable income and thus reducing demand for goods and services; reducing demand-pull inflation.
As explained previously, Australia's CAD continues to grow. This might occur due to its inefficient export base. Thus the government should implement structural change by providing subsidies for research and development purposes, which might give Australia the opportunity to catch up its lack of technology.
Additionally, the government may also apply a tightening fiscal and monetary policy. By applying a tightening fiscal policy, hence the government has less outflow and more inflow, thus lower budget deficit. Having less deficit reduces the need for borrowing overseas; contributing to a improved CAD. Moreover, a tightening monetary policy would reduce aggregate demand, thus reduce outflow on the current account; reducing the CAD as well as inflation. As a result international competitiveness increases, since its exports are cheaper; resulting in higher demand for its $A, thus leading to an appreciation and improved external stability. Nevertheless, the Howard Government tries to maintain fiscal balance over the medium to the long term due to reducing the need for borrowing overseas as well as reducing the “crowding-out” effect; resulting in an improved CAD and thus external stability.
