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Ineconomics, aSwan Diagram, also known as theAustralian model (because it was originally published byAustralian economistTrevor Swan[1] in 1956 to model the Australian economy during theGreat Depression), represents the situation of a country with acurrency peg.[2]
Two lines represent a country's respective internal (employment vs.unemployment) and external (current account deficit vs.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 relativedemand for foreign and domestic goods.
When there is aBOP disequilibrium, either by the market forces or policy measures for readjustments,SWAN model is helpful.Internal Balance looks forward to acquiring full employment with lowest possible inflation, whereasExternal Balance looks 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 adeficit scenario.
To cure theInflation, we would useContractionary monetary policy which would lower it down and bring the economy to anequilibrium point. To curtailUnemployment, we would useExpansionary monetary policy which would do the same as above. In order to cure theCurrent account deficit in 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 wouldovervalue the 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.
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