australia current account
I Introduction
The deterioration in Australia's current account position since the mid-1980s, and the associated increase in net foreign liabilities, has been accompanied by a
vigorous debate as to the major causes, consequences and potential remedies required (if any). In an influential contribution, Pitchford (1989a, 1989b, 1989c)
used the intertemporal approach to argue that Australia's recent current account position should be of little concern, as under the assumption of a virtual absence
of market failure (distortions and externalities), which could be viewed as reasonable in the context of Australia's open and competitive credit markets, the current
account deficit (which has largely comprised an addition to the external liabilities of the private sector) was merely a result of optimizing behaviour by
forward-looking firms and individuals, with no implication of a need for corrective policy measures. A similar argument had been made earlier by Pope (1977,
1986) in the context of New Zealand's current account balance. Pitchford argued that because in Australia's case most of the current account deficit could be
attributed to the difference between private investment and private saving (where the former is driven by profit opportunities and the latter by intertemporal
consumption smoothing), there was little role for government intervention (by such instruments as fiscal tightening) designed to inhibit the creation of private
liabilities (debt) by altering the dynamic path of domestic investment and consumption. 1,2
The Pope-Pitchford view ran counter to those arguing that Australia's burgeoning current account deficits, and consequent rising stock of external debt, needed to
be curtailed before they became economically unsustainable (Arndt 1989, The Economist 1995). This more conventional view recommends that tight
monetary/fiscal policy is needed to restrain aggregate demand and rein in the current account deficit. Using a Mundell-Fleming framework with limited
international capital mobility, the conventional case for macroeconomic action on the current account rests on the existence of externalities (more generally market
failures) in the borrowing process which are not amenable to resolution at the source of their incidence. Other more sophisticated defenses of the conventional
view have argued that current account deficits and the associated build-up of external debt can be matters of public concern if they arise from unsound private
borrowing, or if public and private borrowers create externalities for one another (country risk) because this additional risk is not wholly internalized by individual
borrowers (see Harberger 1986, Corden 1991, 1996 and Wells 1992).
Using only a theoretical model to draw the conclusion that the current account does not matter, without examining the actual data, is an unsatisfactory approach to
answering this important policy question. Similarly, merely examining the data without reference to some objective criteria is also unsatisfactory. The contribution
of this paper is to test whether Australia's actual current account imbalances are sustainable, by comparing them to the optimal path of external imbalances derived
from an intertemporal model. The intertemporal model of [next page]