Swan diagram

Ineconomics,aSwan Diagram,also known as theAustralian model(because it was originally published byAustralianeconomistTrevor Swanin 1956 to model the Australian economy during theGreat Depression), represents the situation of a country with acurrency peg.

Two lines represent a country's respective internal (employmentvs.unemployment) and external (current account deficitvs.current account surplus) balance with the axes representing relative domestic costs and the country'sfiscal deficit.The diagram is used to evaluate the changes to the economy that result from policies that either affect domestic expenditure or the relativedemandfor foreign and domestic goods.

Mechanism

When there is aBOPdisequilibrium, either by the market forces or policy measures for readjustments,SWAN modelis helpful.Internal Balancelooks forward to acquiring full employment with lowest possible inflation, whereasExternal Balancelooks towards a "No surplus - No deficit" position in the economy.

Any point above the internal balance line (or curve) would haveinflation,and any point below it would haveunemployment.Similarly, any point above the external balance line (or curve) would depict asurplus,and any point below it would depict adeficitscenario.

To cure theInflation,we would useContractionary monetary policywhich would lower it down and bring the economy to anequilibriumpoint. To curtailUnemployment,we would useExpansionary monetary policywhich would do the same as above. In order to cure theCurrent account deficitin the economy, we need to increase the exports by adevaluation,that would, in turn, help in increasing the employment by creating more jobs. ForCurrent account surplus,we wouldovervaluethe currency so that the exports are diminished.

The zone above the equilibrium point (the V - shaped) is called the "Critical Zone"because the problem there would be very close to equilibrium. So a policy measure might just worsen the condition by taking, the economy, past the equilibrium point.

References

• Paul Krugman article on Latin American currency and the Swan diagram
• Australian Treasury article on China which discusses the Swan diagram