Hello, without the textbooks on me, here's what I would have written (dot point form) for that.
-Must balance under a floating exchange rate (there's a nice formula you can whack out to impress examiners) once net errors and omissions is taken into account.
-The economic theory is that an initial imbalance between imports and exports (Balance on Goods and Services or BoGS) leads to Net Foreign Debt/Liabilities - the CAD 'drives' the Capital and Financial account. CADs today must be financed by borrowing which shows up as a surplus on the C + F account. This links in to the sort of vicious cycle idea. Surpluses on the C + F account are borrowings that build up the NFD/L into the future. Interest must be paid on our NFD and dividends must be paid for our Net Foreign Equity. These interest + dividends show up as a deficit on the net primary income component of the Current Account Balance, worsening the CAD. This in turn must be financed by a larger surplus on the C + F account. Hence sort of a vicious cycle.
-However, there is also the relatively recent 'Pitchfords thesis' that I think was popularised in the past two decades. It argues that essentially the capital and financial account might drive the current account rather than the other way around. Rather than it initially being an import/export/BoGS/CAD problem, John Pitchford from ANU argued that Australia is a small, open economy with an abundance of business opportunities (in areas such as mining). This has meant that a lot of foreign investment and borrowing has occurred, which has blown out our NFD/L as a % of CAD, but given that these investments/borrowings were made to help firms invest/produce, it should have a net benefit on society - particularly if those investments are in export based industries. Hence rather than a consumer goods, import expenditure driven CAD, Pitchford argued that it was instead an investment, capital goods driven C & F account surplus that lead to our NFL - which is acceptable. I think this is also called the 'consenting adults' thesis. Did that make sense?
Also, national saving is important - higher savings rates means a decreased reliance on foreign savings to borrow and hence smaller amounts of NFD. Helps negate that vicious cycle idea.
I'd personally believe that it's not purely the case of the CAD driving the CF account or vice versa, and both ideas probably apply. You could break it down and say perhaps the initial blow out in the NFD in the 1980s was more of a consumer spending import CAD driven blow out, and the one in the 2000s was a combination of the mining boom (a C + F surplus driven event) + very low savings rates (more CAD driven).
good luck!
(I just read dixon which seemed to match pretty closely to what I said above - what did Riley say? I had to return my Riley to school.)
