Key Takeaways
- • Treasury paper by Phil Garton examines whether a sovereign wealth fund investing in foreign assets, as in Norway and Chile, could meaningfully dampen Australian dollar appreciation caused by the resource boom.
- • The article compares resource-boom experiences in Australia, Norway and Chile, which have seen similar rises in terms of trade, with Norway and Chile operating resource-linked SWF regimes.
- • Norway's Government Pension Fund Global hypothecates all oil and gas revenues, invests solely in foreign equities and fixed income, and sets a structural deficit target of 4 per cent of accumulated funds.
- • Chile's Economic and Social Stabilisation Fund invests solely in foreign assets and is linked to a structural budget balance based on 10-year equilibrium prices for copper and molybdenum.
- • The author concludes that the exchange rate effect of investing budget surpluses abroad is theoretically ambiguous, because general equilibrium effects may offset the partial equilibrium depreciation expected from foreign asset purchases.
Summary
A number of commentators have proposed that Australia establish a sovereign wealth fund to save a larger share of resource-boom tax revenues and to ease pressure on trade-exposed industries from the high Australian dollar. Phil Garton's paper, published by the Australian Treasury, examines the narrower question of whether accumulating foreign assets through such a fund could materially affect the exchange rate. It does not take a position on the overall merits of an SWF.
The paper distinguishes between Norway's and Chile's regimes. Norway's Government Pension Fund Global hypothecates all oil and gas revenues, invests solely in foreign equities and fixed income, and targets a structural budget deficit excluding oil and gas revenues of 4 per cent of accumulated funds, the assumed long-term real return. This design is intended to preserve the fund's real value while allowing fiscal flexibility. Chile's Economic and Social Stabilisation Fund also invests solely abroad but is a stabilisation vehicle, designed to save revenues from above-normal copper and molybdenum prices and draw them down when prices fall below normal. Both regimes share two features relevant to the exchange rate: fiscal rules that produce higher surpluses when commodity prices are high, and investment of those surpluses in foreign assets.
Garton's analysis of the exchange rate begins with the mechanics of a resource boom. Higher commodity export prices raise the equilibrium real exchange rate mainly by increasing demand for non-tradables through a spending effect and a factor movement effect, and by raising the return on resource-sector capital and prompting tighter monetary policy. In the foreign exchange market, higher export receipts and capital inflows increase demand for Australian dollars.
On this framework, tighter fiscal policy from higher surpluses lowers domestic demand for non-tradables and, over time, permits easier monetary policy, which reduces the currency level needed to equalise returns. The effect of investing surpluses abroad is less clear. Although a partial equilibrium view suggests that purchases of foreign assets raise demand for foreign currency and depreciate the domestic currency, the author argues that general equilibrium effects must be considered. In a small economy with perfectly substitutable domestic and foreign assets, foreign funds supply is perfectly elastic, and other investors must absorb additional Australian securities, which can offset the expected depreciation.
The paper frames the Australian, Norwegian and Chilean comparison as a quasi-natural experiment. Its conclusions are conditional on these theoretical channels; the supplied excerpt does not include a full empirical estimate of the exchange rate effect.
The paper distinguishes between Norway's and Chile's regimes. Norway's Government Pension Fund Global hypothecates all oil and gas revenues, invests solely in foreign equities and fixed income, and targets a structural budget deficit excluding oil and gas revenues of 4 per cent of accumulated funds, the assumed long-term real return. This design is intended to preserve the fund's real value while allowing fiscal flexibility. Chile's Economic and Social Stabilisation Fund also invests solely abroad but is a stabilisation vehicle, designed to save revenues from above-normal copper and molybdenum prices and draw them down when prices fall below normal. Both regimes share two features relevant to the exchange rate: fiscal rules that produce higher surpluses when commodity prices are high, and investment of those surpluses in foreign assets.
Garton's analysis of the exchange rate begins with the mechanics of a resource boom. Higher commodity export prices raise the equilibrium real exchange rate mainly by increasing demand for non-tradables through a spending effect and a factor movement effect, and by raising the return on resource-sector capital and prompting tighter monetary policy. In the foreign exchange market, higher export receipts and capital inflows increase demand for Australian dollars.
On this framework, tighter fiscal policy from higher surpluses lowers domestic demand for non-tradables and, over time, permits easier monetary policy, which reduces the currency level needed to equalise returns. The effect of investing surpluses abroad is less clear. Although a partial equilibrium view suggests that purchases of foreign assets raise demand for foreign currency and depreciate the domestic currency, the author argues that general equilibrium effects must be considered. In a small economy with perfectly substitutable domestic and foreign assets, foreign funds supply is perfectly elastic, and other investors must absorb additional Australian securities, which can offset the expected depreciation.
The paper frames the Australian, Norwegian and Chilean comparison as a quasi-natural experiment. Its conclusions are conditional on these theoretical channels; the supplied excerpt does not include a full empirical estimate of the exchange rate effect.
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