Appendix

The role of financial deregulation in the accumulation of debt

In Chapters 3 and 4, we argued that financial deregulation was responsible for Australia’s excessive accumulation of household debt and overseas borrowing, in that it removed constraints on the sale of new debt to households and on borrowing from overseas. In this appendix, we provide a more technical demonstration of the relationship, based on flow-of-funds data.

We have calculated the impact of financial deregulation on the increase in gross foreign debt using a flow-of-funds model of the economy that documents the relationship between five financial subsectors (the Reserve Bank, other banks and deposit institutions, pension and insurance funds, other financial institutions, and investors from the rest of the world) and three non-financial sectors (general government, households, and non-financial corporations). Since 1988, the Australian flow-of-funds statistics, published as part of the National Accounts by the Australian Bureau of Statistics, have estimated the annual flow of funds, via transactions in financial instruments, between each of the five defined financial subsectors and the three non-financial sectors. These data allow the estimation of the average inter-sector financial-flow coefficients that applied between 1988 and 2015. The average pre-1985 structure of financial flows can then be substituted into this model, based on the flow-of-funds data published by the Reserve Bank for the years from 1953 to 1985.

Taking the net lending of the three non-financial sectors as given, total gross foreign debt excluding equity investment can then be calculated for the post-deregulation years, using the 1953–85 coefficients and compared to actual gross foreign borrowing. The difference is 43 per cent of GDP, which may be interpreted as an estimate of the increase in gross foreign debt that has resulted, so far, from the change to the structure of the Australian financial sector wrought by financial deregulation. This is a little less than half the increase in gross foreign-debt liabilities, the other half being largely due to continuing current-account deficits.