RDP 9002: Public Sector Growth and the Current Account in Australia: A Longer Run Perspective 1. Introduction

Over the past five or more years, despite unprecedented fiscal contraction, the current account deficit has risen and inflation has remained stubbornly above the rates in other OECD economies. The purpose of this paper is to place the current macroeconomic situation in Australia in a longer-run perspective and to disentangle broad trends from short-run fluctuations.[1]

In Section 2 we introduce an accounting framework for examining the relationship between fiscal policy, domestic saving and investment, and the current account. In Section 3, we present a range of “stylized facts” about the behaviour of the Australian macroeconomy from 1961/62 to 1988/89. An attempt to explain these facts is presented in Section 4 where we introduce behavioural assumptions into the accounting framework. As this paper is intended to be a broad overview of the major issues, we refer the reader to other papers produced as part of the MSG2 modelling project for the empirical framework underlying the analysis.[2] Finally, a conclusion and summary are contained in Section 5.

There are both positive and normative aspects to this paper. We argue that the gradual deterioration in the balance of payments since 1973 is the macroeconomic consequence of having a larger government sector while maintaining private expenditure. Even though the public sector borrowing requirement has been reduced to zero, the public sector is still a larger proportion of the economy than it was before 1973. The composition of receipts and expenditures is just as important as the size of the fiscal deficit or surplus. Both the level of government spending and the distortions caused by the tax system are important. In particular private sector saving decisions are distorted by the interaction of the tax system and inflation over this period.


The reader is referred to studies by Corden (1988) and Caves and Krause (1984) for further detailed coverage before this period and Maddock and McLean (1988) for a study of Australia's economic performance this century. [1]

The interested reader should refer to McKibbin and Sachs (1989), McKibbin and Siegloff (1988b) and McKibbin and Elliott (1989) for a formalization of the MSG2 model. [2]