External Stability

Demand Factors and External Stability (2)

Demand Factor	Theoretical Impact	Evidence
Consumer Confidence	When consumers are more confident they are more likely to spend their income, and this spending will be divided between locally produced goods and services and imported goods and services. If local production can not meet their demand, spending on imports will increase. This could lead to an increasing CAD and a depreciating AUD.	In 2006/07 consumer confidence peaked at 123.9 on the Westpac Index. At the same time, the CAD expanded to -5.9% of GDP, the most significant deficit we have recorded in recent years. Throughout 2008/09 consumer confidence was generally recorded below 100 on the index, and as a result our spending on imports fell. The CAD/GDP deficit contracted to -4.4%.
Business Confidence	Business confidence will affect external stability in a similar manner to consumer confidence. As business confidence increases they are more likely to spend on imported products to use in the production process. As a result, debits in the CAD may increase at a faster rate than the credits.	In the last five years business confidence peaked at 10.9 (on the NAB index) in 2007. This coincided with the most significant deficit in the current account during this period, which was -5.9% of GDP. When confidence fell in response to the global financial crisis, so did business spending on imported goods and services. The CAD contracted t0 -4.4% of GDP.
Interest Rates	Interest rates can have a very important effect on our external stability. As has been discussed previously, a change in interest rates will affect the spending patterns of consumers and businesses. However, the relative difference between interest rates in different countries can also have a strong impact on the exchange rate. If our cash rate is higher than that in the USA (for example), investors will want to put their money into the Australian overnight money market to get the higher return. This involves buying AUD on the Forex market, and so ultimately leads to an appreciating currency.	The recent appreciation of the AUD against the USD can partly be attributed to the interest rate differential. Although the Australian cash rate was lowered to 3% during 2009, the federal funds rate in the USA was even lower, eventually falling below 0.5%. During that year the Australian dollar appreciated from around US$0.65 in the first quarter to over US$0.90 by the end of the year.
Overseas Economic Conditions	If our trading partners experience strong growth, they will normally increase their demand for our exports. As a result, this can lead to both an appreciating AUD and an improvement in the CAD. While the net income section is unlikely to be affected, the balance on goods and services is far more likely to be a surplus during these periods.	At first glance it may appear that the Australian economy has not followed this trend. In 2009 the global economy moved into recession, and yet the CAD contracted. However, this does not mean that we were selling more exports. On the contrary - exports fell during this period. The CAD contracted because the Australian economy was moving through a negative phase of the business cycle as well. Exports fell, but import spending fell faster.
Exchange Rate	Although it is a measure of our external stability, it is important to understand that changes in the value of the AUD can act as a strong demand factor affecting our external stability. When our dollar depreciates our exports become more internationally competitive, and as a result we will sell more of them. At the same time imports become more expensive, and so we will not buy as many of them. This has obvious implications for the CAD. However, a depreciating AUD can mean that it is more expensive to repay the interest on our NFD. As this is such a large percentage of the CAD, this may have a greater impact than that experienced in the balance on goods and services, and so the CAD may expand.	At the beginning of 2009 the Australian dollar depreciated. This helped our economy to maintain a solid export base in a challenging global economic climate, which contributed to the contraction in the CAD that was seen in that year (falling to -4.4% of GDP). Later in the year the AUD appreciated. The financial crisis had made many Australians wary about holding too much debt, and so some people took advantage of low interest rates and paid down their debts. As a percentage of GDP our net foreign debt fell in this year, and the net income account also contracted. This helped to ensure that our overall balance on current account also contracted (as outlined above).
Disposable Income	As our income increases we will seek to satisfy more of our needs and wants. As this happens, we will purchase more imported products, especially if domestic production is unable to keep up with the increase in demand. This may make our CAD worse, and place downward pressure on the AUD.	Between 2006 and 2008 average weekly full time earnings increased by over $100 per week, and during this period the CAD expanded. By 2009 the average wage for a full time adult was over $60,000 per year, but the onset of the global financial crisis meant that people were working fewer hours. This reduced the overall level of income received during this period, and the CAD contracted to -4.4% of GDP.

Current Page: Demand Factors and External Stability (2)