ATAR Economics Unit 3: External Sector Revision

Comprehensive vocabulary revision flashcards covering external sector concepts including the balance of payments, terms of trade, exchange rates, and foreign investment for ATAR Economics Unit 3.

Balance of payments (BOP)

A systematic record of all economic transactions between the residents of a given economy (individuals, firms, government) and the rest of the world.

Current account (CA)

A balance of payments account that records transactions of a short-term nature: net goods, net services, net primary income, and net secondary income.

Capital and financial account (KFA)

The section of the balance of payments consisting of the capital account (capital transfers, non-produced non-financial assets) plus the financial account (direct, portfolio, other investment, reserve assets) which always offsets the current account.

Trade balance (balance of goods and services)

The value of goods and services Australian residents export less the value of those they import.

Net primary income

Income earned from, minus income paid to, the rest of the world from work (wages) and investment (interest, dividends). Runs a persistent deficit in Australia.

Net secondary income

One-way (current transfer) payments with nothing received in return, such as foreign aid and money brought by migrants.

Capital account

A balance of payments component recording capital transfers (debt forgiveness, conditional capital grants) and the acquisition or disposal of non-produced non-financial assets (patents, copyrights, trademarks, franchises, land and water rights).

Direct investment (FDI)

Financial flows to fund new investment or to purchase $10\%$ or more of an enterprise, giving significant influence or control; long-term and stable in nature.

Portfolio investment

The purchase of less than $10\%$ of equity or of debt securities (such as shares and bonds) conferring no management control; typically speculative and volatile.

Other investment

A functional category in the financial account comprising loans, trade credits, currency, and deposits.

Reserve assets

A financial account category primarily consisting of the Reserve Bank of Australia's holdings of foreign currency.

Net errors and omissions

A statistical adjustment made because of errors or omissions in the balance of payments collection data so that the accounts sum to zero.

Double-entry system

An accounting framework where every balance of payments transaction is recorded as two equal and opposite entries—a credit ($+$) and a debit ($-$)—ensuring the overall record balances.

Credit (+)

A balance of payments entry representing exports, income receivable, an increase in foreign liabilities, or the export of currency, generating an inflow of funds.

Debit (−)

A balance of payments entry representing imports, income payable, an increase in foreign assets, or the import of currency, representing an outflow of funds.

Savings–investment gap

The macroeconomic relationship expressed as $\text{CAB} = S - I$. If $I > S$, Australia borrows foreign savings, leading to a current account deficit and capital and financial account surplus; if $S > I$, it generates a current account surplus.

Cyclical factors (Current Account)

Temporary factors that mainly affect the trade balance, such as business cycles, the exchange rate, commodity prices, the terms of trade, and relative inflation.

Structural factors (Current Account)

Fundamental and permanent economic factors that mainly affect the income balance, including the savings–investment gap, foreign investment levels, and accumulated foreign liabilities.

Terms of trade (ToT)

An index measuring the relative movements in the prices of exports and imports, calculated as $\left(\frac{\text{Export Price Index}}{\text{Import Price Index}}\right) \times 100$.

Index number

A statistical device expressing price changes as a percentage of prices in a chosen base year, which is assigned a value of $100$.

Favourable terms of trade

A movement where the terms of trade index rises (export prices rise relative to import prices), meaning fewer exports are required to buy a given quantity of imports.

Unfavourable terms of trade

A movement where the terms of trade index falls (import prices rise relative to export prices), meaning more exports must be sold to purchase a given quantity of imports.

Commodity currency

A currency, such as the Australian dollar, whose value is strongly driven by commodity prices because primary commodities make up approximately $\frac{2}{3}$ to $70\%$ of total exports.

Real GDI

Gross domestic product adjusted for the terms of trade, serving as a superior measure of the real purchasing power of national income compared to $GDP$.

Dutch disease / two-speed economy

A condition in which a high exchange rate caused by a mining boom damages non-mining traded sectors (such as manufacturing, tourism, and education), leading to uneven growth across industries.

Exchange rate

The price of one country's currency in terms of another country's currency.

Trade-weighted index (TWI)

A weighted average of a basket of foreign currencies reflecting the relative importance of Australia's trade by country, with the RMB, euro, USD, and yen accounting for $64\%$.

Floating (free) exchange rate

An exchange rate system where currency value is determined purely by market forces of demand and supply, changing whenever demand or supply shifts.

Clean float

A floating exchange rate regime where the central bank does not intervene in the foreign exchange market.

Dirty (managed) float

An exchange rate regime where the central bank intervenes by buying or selling currency or altering interest rates to influence the currency's value (described in Australia as 'testing and smoothing').

Fixed (pegged) rate

An exchange rate system where the value of a currency is artificially set and maintained at an official rate by the government or central bank.

Appreciation

An increase in the value of the domestic currency, enabling it to buy more foreign currency, caused by an increase in demand for the AUD or a decrease in its supply.

Depreciation

A decrease in the value of the domestic currency, meaning it buys less foreign currency, caused by a decrease in demand for the AUD or an increase in its supply.

Interest rate differential

The difference between the Australian interest rate and the US interest rate (measured using $3$-year government bond rates). A rise attracts foreign capital and appreciates the AUD.

J-curve effect

The economic phenomenon where a currency depreciation causes the trade balance to worsen in the short run due to inelastic demand and existing contracts before improving over time as trade volumes adjust.

Hedging / forward contract

The practice of agreeing today on an exchange rate for a currency purchase or sale occurring at a future date, eliminating exchange rate uncertainty.

Foreign investment

Flows of financial capital into and out of the Australian economy through the buying and selling of financial assets.

Foreign liabilities

The accumulated stock of foreign investment made into Australia, representing what Australian residents owe to overseas entities.

Foreign assets

The accumulated stock of Australian investment abroad, representing what Australian residents own overseas.

Net international investment position (NIIP)

The net financial obligation of an economy to the rest of the world, calculated as total foreign liabilities minus total foreign assets.

Foreign debt

The monetary borrowings that Australian residents owe to overseas lenders, serviced over time via interest payments.

Foreign equity

The extent to which foreign investors own assets or equity in Australian enterprises, serviced by outflows of distributed profits and dividends.

Gross foreign debt

The total aggregate value of all borrowing from overseas lenders by residents of an economy.

Net foreign debt

Gross foreign debt minus Australian lending to overseas residents, providing the best measure of net outstanding debt abroad.

Capital deepening

An increase in the ratio of capital per worker through superior equipment or technology, driving higher labour productivity, output, and income.

Stock vs flow

A stock represents an accumulated total measured at a specific point in time (e.g., foreign debt), whereas a flow represents an economic measurement over a defined period (e.g., GDP or the annual financial account balance).