During the second half of the 1980s, Australian academics began to debate whether the current account deficit was an appropriate target of macroeconomic policies and whether the view that the deficit was unsustainable was correct. This debate was led by John Pitchford; however, the ‘Pitchford thesis’, or ‘consenting adults’ view as it is commonly known in Australia, can be traced back to Max Corden who
had expressed very similar views in his 1977 book (Corden 1977).
The Pitchford (1989b, 1989c, 1990) thesis rests on the understanding that the
current account balance is the net result of investment and saving decisions that
have been made by agents within the economy. If these decisions are made
optimally, then any resulting current account deficit (or surplus) cannot be
considered a cause for concern. After all, a deficit merely represents households
deciding to consume now rather than later and firms deciding to take advantage of
profitable investment opportunities in Australia. These decisions are optimal
– therefore welfare maximising – and households and firms have made these
decisions with every expectation that they will have the capacity to repay. The
foreign investors lending the money are obviously of the same mind. The deficit,
therefore, is the result of decisions between ‘consenting adults’. At the time these
arguments were being put, the Australian Government was running a budget
surplus and the public sector borrowing requirement was low, and therefore the
current account deficit could be largely considered the outcome of private
decisions.
The Pitchford thesis fundamentally countered established thinking on the current
account deficit – that is, the notion that large current account deficits are always
unsustainable or can ultimately impose a constraint on growth. Rather than
imposing a constraint on growth, a current account deficit is a means by which
advantage can be taken of profitable investment opportunities, thereby raising
potential growth. Capital flows into Australia are presumably the result of foreign
investors seeking high returns, benefiting both the borrowers and lenders in the
process.
The key message from Pitchford and others was that there was no role for
macroeconomic policies to respond to current account deficits and that current
policies aimed at reducing the current account deficit might be severely misplaced.
If there was a role for government at all in addressing the current account deficit, it
would be to remove distortions and externalities adversely affecting decisions of
private agents. Even then, the first-best solution would be to use micro-based
policies to remove the identified problems at their source.
The rationale behind existing policy strategies was also challenged. The ‘twin
deficits’ argument – on which the fiscal consolidation strategy was seemingly
based – was convincingly refuted as it assumes that private behaviour will not
change in response to changes in government behaviour (for example Argy 1990).
This does not imply that fiscal consolidation is inappropriate, just that it would not
necessarily reduce the current account. The argument that microeconomic reforms
would necessarily lead to a reduction in the current account deficit was also
disputed. Such reforms might make markets operate more efficiently, but does that
mean agents would invest more or less? Save more or less? This ambiguity led to
the view that microeconomic reform, while worthwhile for its own sake, should
not be pursued in order to influence the current account. Otherwise, you might not
undertake reforms if they are likely to lead to an increase in the current account
deficit but are otherwise beneficial (Pitchford 1989a, p 11).
While many were to side with Pitchford in his thinking, other academics and
policy-makers did not, particularly with regards to the ‘hands-off’ approach. Some
questioned the new framework and viewed it as untested, instead suggesting that
policy should be based on the more established way of thinking (see, for example,
Nguyen 1990). Most arguments, however, did not question the framework but
rather emphasised practical considerations (see, for example, Corden 1991).
First, it was argued that private agents are not always able to make optimal
decisions. Distortions and externalities exist, which interfere with incentives and
provide a rationale for policy intervention. Moore (1989) argued that there were
plenty of examples in history of excessive borrowing by nations that had ended in
a debt crisis. Second, an agent’s decision that leads to an increase in external debt
may impose costs on other borrowers in the form of higher interest rates through
the imposition of a risk premium applying to the country as a whole. Third, there
were risks to the economy if there was an adverse swing in sentiment of foreign
investors, possibly resulting in a sharp and possibly severe adjustment process. In
this case, it was preferable that some adjustment was undertaken pre-emptively
through appropriate restrictive policy settings (Argy 1990).
While many of these counter arguments have valid elements, in many cases they
are not concerned with the current account deficit per se, but see it as a symptom
of another underlying problem. The appropriate policy response, then, is to address
the underlying problem, be that overspending or the distortions and externalities
themselves.
The intellectual weight of the Pitchford thesis started to be acknowledged by
policy-makers by the late 1980s. In September 1989 and again in June 1990, the
then Deputy Governor of the RBA, John Phillips, gave credence to the Pitchford
argument stating that the balance of payments was a reflection of the ‘community’s
attitudes to savings, consumption, investment and debt’ (Phillips 1989, 1990), and
as a result, the current account deficit was not an appropriate target of monetary
policy. Instead, the appropriate role for monetary policy was controlling inflation
and the RBA’s stated concern that the current account deficit was unsustainable
started to wane. A few years later, the Government also expressed the view that
monetary policy should not be used to target the current account (see, for example,
Commonwealth of Australia 1991, p 2.33).
In the early 1990s, the Australian Government acknowledged the broader
implications of the Pitchford thesis, but had reservations about how well it would
apply in practice, in line with many of the arguments outlined above (see, in
particular, Commonwealth of Australia 1991, p 2.36).16 While strategies such as
micro reform and fiscal consolidation were important in their own right (and for
broader goals such as raising national saving), they were continually framed as
strategies to address the current account deficit ‘problem’.17
Likewise, the RBA did not at this time entirely accept the view that the current
account deficit should not be a concern at all. It was deemed to be ‘… a mediumterm
problem …’, where deficits of around 5–6 per cent probably were not
sustainable (Fraser 1994, 1996). Since 1996, the current account deficit has no
longer featured as part of the monetary policy debate. In 2004, Glenn Stevens, the
then Deputy Governor, restated the RBA’s view as thus: ‘… whether the current
account deficit should be a target of any policy is not obvious – it would need to be
argued. But whatever one’s view on that question, the current account is not, and
should not, be an objective of monetary policy’ (Stevens 2004, italicised as per the
original).
The dissenting voices to the Pitchford view – in both academia and policy
institutions – from within Australia have now largely disappeared. If concerns are
raised, they generally herald from international organisations, such as the
Organisation for Economic Co-operation and Development (OECD) or the
International Monetary Fund (IMF), in their assessments of the external
vulnerabilities facing Australia.
