Economics Essay: Foreign Trade

a) Explain what is meant by a Current Account Deficit and why is it considered 'bad' to have an increasing
CAD?

The Current Account Deficit generally means that our nation is spending more than it earns. This means
that we have to borrow from other countries in order to pay for the things we purchase (imports). When we
borrow from them we have to pay interest rates and these are additions to the original debt, therefor they
increase the total debt owed.

It is considered a bad thing to have an increasing current account deficit because we are borrowing from
other countries and then repaying them even more, due to interest rates. We are increasing the flow of
money out of our economy and into a foreign economy.

Another reason why an increasing current account deficit is considered a bad thing is because it affects the
exchange rate, as a reduction in the Australian dollar restricts the things we import.

b) What are the main reasons for Australia experiencing a sustained CAD?

Australia is experiencing a sustained current account deficit for many reasons. These reasons include: high
interest rates, worsening terms of trade, high consumer spending and less saving, inflation, variations of the
exchange rate, freight and tourism and international competitiveness.

The first reason is the fact that interest rates on existing debt are high as well as the fact that we don't save
enough, adds a considerable cost onto the final debt. Higher interest rates drive us further into debt than we
began with, leading to a greater debt.

Second is worsening of terms of trade. When import prices rise faster than export prices, the terms of trade
will turn against us. We will sell what we make at a cheaper price than what we bought it for.

High consumer spending is another reason for the sustained current account in Australia. If the government
spends more than it takes from people (taxes), a deficit budget occurs. This increases consumer spending
even though we can't afford it.

Inflation also contributes to the current account deficit as it influences international competitiveness. If
workers wages don't match the level of productivity, then businesses don't match overseas performance.
This loses international competitiveness, another factor contributing to the current account deficit.

Freight is also a reason why the current account in Australia is sustained. Australia is such an isolated
country and doesn't have a major shipping line. Therefore we must pay transport costs as well as higher
insurance rates. These two factors add to the cost of imports once again.

Tourism also creates a higher current account deficit for Australia as it has been proven that we spend more
money in foreign countries (e.g. on holidays) than they do here in Australia. Also, many foreigners want to
invest in Australia, therefore they buy out businesses.

Different exchange rates are another contributing factor. The foreign debt is recorded in foreign currency.
This means that if the Australian dollar depreciates then the principle and interest rates of the debt will also
increase, leading to an increase in the total debt in turn.

c) What government policies/strategies could be implemented to reduce Australia's CAD?

External balance is when a country has a recurring and large account deficit. To reduce the current account
deficit there are many things that can be done.

Depreciation is the first one. If there is depreciation in the Australian dollar, import prices will rise and
export prices will fall, leading towards a high demand for exports and a reduction in the cost of imports.

Another way is to reduce inflation. With a high inflation rate there is an increase in a country's output
against other countries. This leads towards higher demand for imports and a decreased demand for exports,
also leading towards a reduction in the current account deficit.

Increased productivity is another way that the current account deficit can be reduced. If workers rate of
productivity increased then so will the nations competitiveness. This will then increase exports, lowering
the current account deficit.

Another method is to use tariffs and quotas on imported goods and services that would restrict the amount
of imports that could be purchased. Reducing purchasing power means that we won't have the freedom to
import as much as we do at the moment. This method wouldn't work really because as