As our external stability is assessed by watching the fluctuations in three different measures, each has its own manner of measurement.
In 1983 when the Hawke government assumed power, one of the first decisions that was made was to “float” the Australian dollar. Prior to this, the Australian dollar was pegged against movements that were experienced by other countries. Floating the dollar meant that its value would be determined by the supply of the dollar and the demand for the dollar in the foreign exchange market (which you will often see called simply "the Forex market").
The float of the AUD is referred to as a “dirty float”. This is because the RBA is able to intervene in the market for the AUD to affect its value. This could be done by buying AUD to restrict supply (if the value appears too low), or by offering AUD for sale and increasing supply (if the value appears too high). This will be covered in more detail in the section on monetary policy (Unit 4).
Movements in the value of the dollar are referred to as either an appreciation or a depreciation of the currency. An appreciation is when the value of the Australian dollar (AUD) increases. That is, one Australian dollar will now buy more of the other currency. On the other hand, a depreciation is said to occur when the value of the AUD decreases – when one Australian dollar can no longer buy as much of the foreign currency as it previously could. An example will make this clear.
Let us say that the value of the Australian dollar can be expressed as $1AUD = $0.72USD. In this case, we are saying that one Australian dollar will buy 72cents in the USA. For some reason, the value of the AUD changes, so that now we can say that $1AUD = $0.75USD. In this case, the AUD has appreciated – we can buy more of the US currency with each AUD that we offer than we previously could.
Fluctuations in the value of the dollar are determined by the forces of supply and demand. Demand for the AUD will occur when people and organisations from overseas want to buy our currency. This could be due to a high demand for our exports or a desire to invest in the Australian economy. Supply of the AUD is created when our currency is available for sale on the Forex Market. This will happen when our currency is used to purchase more from overseas than we buy, or when we choose to use our local currency to purchase international currencies for investment overseas.
Australia’s exchange rate can either be expressed against one other currency (as we are used to seeing in the newspaper) or against all of our trading partners at once. This is referred to as our Trade Weighted Index, and it is a very important measure to use when considering our overall ability to trade with all of our major trading partners.
Our net foreign debt (NFD) can be assessed in a number of ways. We accumulate debt when we borrow from overseas to fund local projects. This can be expressed as either a percentage of GDP, or as a raw figure. For example, we can say that in 2001/02 Australia’s NFD was 47% of our GDP for that year. However, we can also say that in the same year our NFD was $313.5 billion, and our gross foreign debt was $489.8 billion. We could also say that this represented a 12% increase on the previous year.
Unlike our exchange rate, the level of NFD tends to increase every year. However, as our GDP will also generally increase in most years, economists find it useful to express it as a percentage of GDP. When expressed in this manner, analysts can see whether or not our economy is relying on debt to a greater or lesser extent.
The balance on current account is one part of the Balance of Payments. In general we would assume that the two sides of the Balance of Payments will “balance” each other out – if the current account has a deficit balance of $25 billion, then the combined effects of the capital and financial accounts will be a surplus of $25 billion.
The current account is made up of four sub-accounts:
When calculating the balance on current account, exports are recorded as CREDITS, while imports are recorded as DEBITS. As such, for each section we will calculate the credits minus the debits, and then add the four sections together. The result will be our balance on current account.
On the other side of the Balance of Payments, it is also important to consider the capital and financial accounts. Each account will record a different type of international financial transaction.
The Capital Account: This is where we record the net inflow of funds belonging to people who permanently move from one country to another. We also record any movement of certain assets, such as copyrights, patents, franchise holdings and trademarks.
The Financial Account: This account is made up of four main sections.
After all of this it is very unlikely that the two sides of the BoP will actually balance. This is because there are many estimates involved in the calculations. As a result, a separate account called “Net Errors and Omissions” is listed. This account is simply a balancing figure, used to ensure the two sides really do match. As the title suggests, it accounts for any figures which were estimated incorrectly, or figures that were overlooked during the calculation.