Unit 1
Unit 2
Measurement and Performance
In Unit 1, you learned to analyse the impact of supply and demand factors on the domestic economic goals of the Australian government. You should also understand the way in which these factors can affect the external measures that we use.
For example, what relationship would you expect to see between income tax rates and the balance on current account? At first thought it might seem that these two statistics are unrelated, but a more careful analysis will reveal that there is, in fact, a very logical association.
The rate of income tax is a demand side factor. We know this to be true, because it will affect the spending patterns of individuals. When income tax rates fall, consumers will have more disposable income. At this time, we can expect to see an increase in consumption spending. It is also reasonable to expect that at the same time we will see an increase in spending on imports. Consumers (and businesses) tend to spend a relatively consistent percentage of their income on imported goods and services. If our disposable income increases, and the percentage spent on imports remains constant, then we would expect to see an increase in spending on imports.
As a result, it is logical to conclude that there will be a deficit in the net merchandise and net services accounts. (When you are analysing the impact of a supply or demand factor on the current account, you must always specify which sub-accounts will be affected.) If this occurs, then the deficit in the current account will expand.
Recent statistics certainly seem to support this argument. Between 2003 and 2007, Australian wage earners received significant income tax cuts. At the same time, economic boom conditions in China helped to ensure that demand for our exports was at an all time high. Despite this, the current account deficit remained in excess of 5% of GDP throughout this period. Our export levels were high, but our import levels were even higher.
As a very general rule, we can say that any increase in aggregate demand will lead to an increase in the size of the current account deficit. There are only a few instances in which this is not true.
Any time that aggregate demand increases due to changes in the external sector, the CAD should improve. This occurs when international economies are moving through a strong phase of the business cycle, and also when the value of the Australian dollar depreciates. In each case we would expect to see an increase in exports. This will result in an increase in aggregate demand, and also an improvement in the CAD.
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