External Stability

Policy Approach

External stability has become a major focus of the Australian economy over the last 10 years. The globalisation of the Australian economy gained momentum in the 1980s, however at that time the policy approach towards this goal had not been adequately refined.

For example, in the late 1980s Australia experienced a significant increase in the current account deficit. At that time, monetary policy was tightened in an effort to reduce demand for imports. The impact of this approach was two-fold. First, demand for domestic products fell also. And secondly, with the increase in interest rates the AUD also appreciated. The increasing AUD made imports more affordable, and so demand for imports actually increased, the opposite of that which was intended. As a result of this, Australia experienced “the recession that we had to have”.

Since that time, the approach to external stability has been significantly refined. Monetary policy is now used primarily to target inflation – a domestic goal. However, in so doing the RBA is also ensuring that the international competitiveness of the Australian economy is being maintained in the medium term.

In a similar manner, the Australian government has implemented a range of structural reforms, designed to increase the efficiency of the Australian economy. This should lead to higher levels of production without any upward pressure on prices. In particular, the government has been keen to maximise the efficiency of certain infrastructure industries, such as telecommunications, airlines, postal services and the ports. The result has been a consistent increase in productivity levels in the Australian economy, and a strong improvement in our international competitiveness. In his speech in May 2007, the former federal treasurer Mr Peter Costello announced that the government would commit funds to improve the road and rail infrastructure in Australia. These changes will allow stocks to move more easily through the country, and at a lower cost. This will also add to the international competitiveness of the Australian economy.

However, the major focus on external stability has been through the use of fiscal policy. After the large deficits of the early 1990’s, in 1996 the newly elected Liberal government altered the manner in which fiscal policy was implemented. By changing to a process of fiscal consolidation, the government is aiming to have no net call on national savings over the course of the business cycle. This should allow for the domestic money supply to remain strong, and so borrowing from this pool is now more readily available. This will reduce pressure on the net foreign debt. Similarly, the Liberal government was able to use the surplus funds (nine of the eleven budgets that were handed down while they were in power) to retire debt – government debt was reduced by $96 billion during their term in office. Ongoing stable fiscal policy will also ensure that the country is seen as being financially sound, which will attract foreign funds. This will ensure the stability of the currency, and work to reduce the current account deficit.

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