The Theory of Interest as Determined By Impatience to Spend Income and Opportunity to Spend It
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However, that the higher average rate of asset price growth for portfolio equity compared to direct equity investment, at least in part, reflects measurement issues. Financial derivatives exhibited a very high return for both Australian and foreign investors, possibly reflecting their high-risk exposure relative to capital value.
On the other hand, debt securities and other investments have low average capital gains, reflecting the nature of these securities. This outcome is not surprising, as although in the short run the value of debt securities can vary significantly, over the life of the instrument these fluctuations cancel themselves out. Overall, the pace of growth of net foreign liabilities as a share of GDP has slowed over the course of the s, with little net growth in the second half of the s. This reflects the current account deficit stabilising as a share of GDP in turn reflecting lower net income deficit outcomes , a reversal of the valuation impact of a depreciation in the exchange rate effect, and a higher rate of asset price appreciation on Australian investment abroad than on foreign investment in Australia.
The second driver of the net income deficit is the average yield on net foreign liabilities. The average yield on net foreign liabilities is affected not only by the yield required by foreign investors in Australia, but also by the level of Australian investment abroad and the relative yield on that investment. To analyse these factors a broad conceptual framework is needed for what drives the expected return on investments. In the context of international investment, the impact of expected nominal movements in the exchange rate on the value of an investment also need to be taken into account in the expected return.
However, consistent with international standards, the effect of exchange rate variations on the capital value of investments is not classified as income in the balance of payments, and is therefore not included in the measured yield on investment. Similarly, the expected yield on foreign investment in Australia will reflect the yield on Australian risk-free debt, the relative riskiness of investments undertaken in Australia and the market premium.
This yields an expression for the difference between the yield on Australian investment abroad and foreign investment in Australia. Consistent with the approach for exchange rate variations, the currency and time to maturity 16 of Australian investment abroad is determined by reference to ABS data as far as possible, with similar patterns assumed to prevail in the preceding period. However over the course of the past year or so, the net income deficit decreased at a time when world interest rates rose. This suggests that fluctuations in world interest rates alone are not able to explain the significant decrease in the net income deficit over the recent years.
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The past two decades have seen significant fluctuations in the premium on foreign investment in Australia the extent to which the average yield 17 on foreign investment in Australia has exceeded the average yield on Australian investment abroad In the first half of the s, the average premium was around of a per cent.
The premium increased to around 1 per cent in the second half of the s and 2 per cent in the first half of the s, peaking at around 3 per cent in the early s. Subsequently, the premium on foreign investment has declined to average around 1 per cent in the second half of the s, and around of a per cent in the September quarter Chart 8. The currency and time to maturity 19 of foreign investment in Australia is determined by reference to ABS data as far as possible. Further, over the past two decades the country premium has explained much of the variation in the average difference between the yield on foreign investment in Australia and Australian investment abroad Chart However, it is difficult to separate the two measures with precision.
Douglas and Bartley noted the downgrading in the late s of Australian Commonwealth Government debt by both Standard and Poor's and Moody's was not inconsistent with the argument that this may have been associated with a small country risk premia of around 0. More recently, Standard and Poor's upgraded their rating of Commonwealth Government debt in , citing fiscal consolidation and a transparent medium term fiscal policy framework; the medium term framework for monetary policy and resultant low inflation environment in Australia; and continued structural reform in the labour and product markets, as factors supporting the upgrade.
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Changes in the investment risk premium, in particular, changes in investors' ex ante risk preferences, are difficult to observe in practice. In the current context, discussion is limited to analysis of the ex post yield on direct and portfolio equity securities. Direct equity investments are those where the investor has an equity interest in 10 per cent or more of the ordinary capital or voting stock of the enterprise. In the first half of the s, direct equity foreign investment in Australia yielded a lower return than Australian direct equity investment abroad.
While returns were similar in the second half of the s, in the early s a wedge opened up between the returns, with foreign investment in Australia resulting in a higher yield than Australian investment abroad. Nevertheless, this premium has declined in recent years, from around 4 per cent in the mids to around 2 per cent in the September quarter Chart The difference between these two premia is the ex post investment risk premium.
On the face of it, it appears that the investment risk premium increased over the course of the s, remaining relatively stable at 2 per cent in the second half of the s.
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However, it should be remembered that the ex pected return on direct equity investment includes the effect of expected asset price and exchange rate variations, which - consistent with international standards - are not included in income by the ABS. These results - while volatile - suggest that, on average over the s, the total yield on Australian direct equity investment abroad exceeded that on foreign direct equity investment in Australia.
Portfolio equity investment is defined as equity investment other than direct investment or reserve assets. That is, equity investments are classified as portfolio in nature if they comprise less than 10 per cent of the issued equity capital of the entity. Portfolio foreign equity investment in Australia has consistently yielded more than Australian portfolio equity investment abroad Chart However, both yields are significantly below that on direct equity investment.
This is likely to reflect the fact that the ABS - consistent with international standards - only record the dividend component as income. By comparison, retained earnings and undistributed branch profits are also included in income for direct equity investments. Thus, the higher yield of foreign portfolio equity investment in Australia suggests that the Australian companies pay a higher proportion of their earnings to shareholders as dividends. As with direct equity investments one way of adjusting for these factors is to include the effect of expected asset price and exchange rate variations to derive a total ex post yield on portfolio equity investments.
On this basis, the average yield on portfolio equity investments has been about the same over the decade of the s for Australian investment abroad and foreign investment in Australia.
It appears that a reduction in the premium between Australian interest rates and those in other developed countries since the mids has been an important factor in the recent decline in the net income deficit as a share of GDP. Australia's net foreign liabilities stood at 58 per cent of GDP in the December quarter In addition, the impact of any premium on foreign investment in Australia increases with the level of Australian investment abroad. The decline of the net income deficit is both a function of a significant slowing in the rate of growth of Australia's net foreign liabilities and a reduction in the average yield on net foreign liabilities.
The debt servicing ratio - the level of exports required to pay the interest on net foreign debt - was 9. The net liabilities servicing ratio - the level of exports required to pay the cost of servicing foreign liabilities both debt and equity - was Fisher pioneered a new theory that integrated all the aspects of the fundamental changes.
He called it the theory of interest and defined the interest as "an index of a community's preference for a dollar of present income over a dollar of future income. Fisher, Irving.
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Fisher called interest "an index of a community's preference for a dollar of present [income] over a dollar of future income. Interest rates, Fisher postulated, result from the interaction of two forces: the "time preference" people have for capital now, and the investment opportunity principle that income invested now will yield greater income in the future. Rating details. Book ratings by Goodreads. Goodreads is the world's largest site for readers with over 50 million reviews.
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