CAD (1 Viewer)

[ohsofluffy]

How can a high CAD act as a speed limit on economic growth?

 

[asadass]

Higher levels of economic growth generally involve an increase in imports and a deterioration in the CAD. Economies with a CAD problem are therefore forced to limit growth to the level at which the CAD is sustainable.

 

[deswa1]

Going off that, an increasing CAD is associated with an increase in foreign debt to fund it. Thus, as foreign debt increases, investors might feel that it is no longer safe to invest in that particular nation. To curb this, governments employ contractionary fiscal/monetary policy to keep the CAD sustainable.

 

[gnrlies]

CAD's are not really a bad thing in of themselves. I don't know that I agree with the statement....

 

[munitz]

its a largely debatable topic. If i were you read up on the Pitchford theory, itll give you a good grounding for understanding all aspects of CAD.
But Deswa1 is correct theoretically in his statement. However if you look at australias growth and effects of the cad i would hardly say they are negative. Highest terms of trade in 140 years, didnt fall into a technical recession etc but then again interest payments out of the country reached as much as 29 billion in 2009 so its more a investor confidence thing then anything else. The CAD itself poses no harm and with australias reputation triple AAA rating and good debt servicing ratio due to high terms of trade and an inelastic export market (minerals to china) the CAD doesnt effect australia very much. Pitchford theory explains it really well

 

[powlmao]

No one really Has answered this correctly.

In short: high cad means more funds flow overseas as servicing costs, foreign (asain) liabilities etc. Therefore money leaves Australia causing

Leakages > injections.

And if you dont know wha the above means you shouldn't do economics. In short it means a contraction in the economy. Hence the speed limit

 

[gnrlies]

No one really Has answered this correctly.

In short: high cad means more funds flow overseas as servicing costs, foreign (asain) liabilities etc. Therefore money leaves Australia causing

Leakages > injections.

And if you dont know wha the above means you shouldn't do economics. In short it means a contraction in the economy. Hence the speed limit

But what if a CAD is used to finance investment? Through that channel injections > leakages.

In actual fact it is a constraint on future consumption (and possibly investment). Not a constraint on growth. Debt trap scenarios can be a constraint on growth where it removes the capacity for investment within the economy. But in actual case, a CAD actually contributes towards economic growth - at least in the current period.

 

[munitz]

No one really Has answered this correctly.

In short: high cad means more funds flow overseas as servicing costs, foreign (asain) liabilities etc. Therefore money leaves Australia causing

Leakages > injections.

And if you dont know wha the above means you shouldn't do economics. In short it means a contraction in the economy. Hence the speed limit

that is true in theory. But not in Australia. Australias high CAD is a result of high levels of foreign investment and foreign borrowing due to the fact that australia has a low level of savings and reserve assets. Most of australias large firms are foreign owned and so are the majority of mining industries, which means that in a boom situation growth in all sectors increase, leading to increased profits and dividends flowing over seas which increases the CAD (because the companies are foreign owned). A cad in Australia doesnt have as much as a contractionary effect as is theorised. High levels of investment leads to high levels of borrowing (due to low savings) leads to high levels of money flowing out of the country leading to high foreign liabilites and a high net primary income account (which makes up 60-70% of the current account). But because we have an inelastic export market and extremely high terms of trade, we are able to service all of out net foreign debt. As long as Cad doesnt rise above 6% of GDP and inflation stays low, there is no reason that CAD should act to contract the economy in Australia, infact higher levels of CAD generally mean higher levels of growth. If you look at the trends, the highest levels of CAD in australia were during the mining boom pre GFC.

 

[powlmao]

Obviously you have put alot of work in and technically you are right.

However @OP doesn't fully understand what CAD implications. Therefore a simple explanation is better such as CAD causes injections < leakages.

Simplicity helps alot in the hsc

 

[gnrlies]

Powlmao is correct, simplicity sometimes helps, but in an extended response a more nuanced response is required in order to achieve the top marks. Over simplification can also be detrimental. That is what is good about these forums as issues can be discussed and debate around these issues can add value to everyones own understanding of the topics. But you are right, it can help to stick with the basic story first...

 

[powlmao]

True. But if you Grasp the basic concept it will help you write your essays better as you can incorporate relevant information