Australian Exchange Rate Essay Research Paper What

Australian Exchange Rate Essay, Research Paper

What factors affect the demand and supply of Australian dollars in the foreign exchange markets? Distinguish between the possible causes and effects of a currency depreciation and a currency grasp on the Australian economic system. What forces have come into drama, if any, in the past four months that have affected the value of the Australian dollar? ?

Exchange Rate: ? The rate at which one unit of domestic currency is exchanged for a given sum of foreign currency?

A Brief HISTORY OF THE AUSTRALIAN DOLLARUntil 1971, the Australian dollar ( AUD ) was? pegged? to the British lb. This meant that the AUD rose or fell in line with the lb. In 1971, the AUD became pegged to the US dollar alternatively. These currencies were fixed currencies, which meant that the Australian currency would merely alter value when a major universe currency besides changed. This system lasted merely until 1974 when the AUD became pegged to a trade-weighted choice of other currencies. This was still a fixed currency. In 1976 this choice of currencies became movable. Small displacements were able to take topographic point when needed. In 1983 the AUD became a floating currency. This means that the value of the dollar is determined by supply and demand. Initially, the Reserve Bank of Australia was non intended to step in in the market nevertheless since so it has been deemed necessary for intercession to take topographic point, normally to shore up up the monetary value.

FACTORS AFFECTING SUPPLY AND DEMAND OF AUSTRALIAN DOLLARSWith a floating exchange rate, such as Australia? s, supply and demand factors mostly determine the dollar? s equilibrium monetary value. The exchange rate is sensitive to alterations in both demand and supply, which can do alterations in the equilibrium exchange rate. Another factor, which can impact the supply and demand of Australian dollars, is intercession in the market by the Reserve Bank of Australia.

DEMANDThe demand for Australia? s currency in the foreign exchange market ( Forex ) is a derived demand. It is derived from the demand for a state? s exports of goods and services and its assets.

In simple footings, people who may hold a demand for the Australian dollar could include:

Foreigners desiring to buy Australian exports

International tourers sing Australia

International investors wishing to buy Australian portions or belongings

International houses puting up subdivisions or spread outing in Australia

Speculators and investors who think the value of the Australian dollar will lift in hope of doing a net income.

The demand for the Australian dollar will be affected by a figure of factors. These factors are:

The Size of fiscal flows into Australia

The size of fiscal flows into Australia from investors who wish to put in Australia and need to change over their currency into AUD will impact demand for the dollar. The degree of capital influx will be affected by the degree of Australian involvement rates relative to abroad involvement rates every bit good as the degree of assurance in the Australian economic system. If Australia has comparatively higher involvement rates and stronger assurance, so this will promote capital influx and increase demand for the AUD. Using this theory, the Australian dollar at the present expressions to be in a comparatively strong place. Interest rates are get downing to lift ( official involvement rate has late been risen 0.25 points to 4.5 % and is expected to raise to 5.25 % by September this twelvemonth, with economic growing expected to be about 3.75 % in 2002/03. ) Besides increasing the assurance in future economic growing is the recent budget. The 2002/03 budget released on 14th May 2002 was a shortage budget. This means that the authorities has spent more than it has earned. This is an injection of money into the Australian economic system and will excite economic activity and growing.

Monetary value Expectations

Expectations of a future grasp of the AUD will increase the demand for the AUD by speculators as they expect to do a net income from purchasing the dollar now and selling at a ulterior day of the month at a higher monetary value.

The Demand for Australian Exports

The demand for Australian exports varies for a assortment of grounds. One ground is alterations in trade good monetary values. Another is the footings of trade. These two fluctuations tend to hold an immediate impact on the AUD. A rise in trade good monetary values and an betterment in the footings of trade are by and large expected to better the Current Account Deficit ( CAD ) . This will frequently ensue in an addition in the value of the AUD because of the outlook that the CAD will better over the short to medium term.

The demand for Australian exports is besides influenced by the degree of international competition and the Australian rising prices rate relation to other states. If Australian houses are competitory in the universe market and Australia? s rising prices rate remains low, it means that Australia? s exports will be cheaper to aliens, doing them more attractive to purchase.

Changes in universe income degrees will besides act upon the abroad demand for Australian exports. The demand for Australia? s trade good exports in peculiar are extremely dependent on the degrees of income of Australia? s trading spouses. When the universe economic system is in a period of upturn, demand and monetary values for Australian exports will lift.

Besides impacting universe demand for Australian exports are merely the gustatory sensations and penchants of abroad consumers for Australian exports.

An addition in demand for Australian dollars by and large causes the value of the currency to appreciate. A supply and demand curve is shown over the page, showing an grasp of the dollar.

SUPPLYThe supply of Australia? s currency is besides derived. It is derived from the demand of Australia? s occupants for foreign goods, services and assets.

Peoples who could perchance make a supply of Australian dollars are:

Aussies who want to purchase imports from abroad

Australian tourers traveling overseas

Australian Bankss and houses imparting or puting money overseas

Aussies paying for assorted services from abroad such as refunding loans or paying involvement on loans

Speculators and investors

The supply of Australian dollars will be affected by a figure of factors. These factors are:

The size of fiscal flows out of Australia

The degree of fiscal flows out of Australia will besides be determined by the domestic involvement rates relative to overseas every bit good as international assurance in Australia and other economic systems. If Australian involvement rates are comparatively lower and the assurance in the Australian economic system has deteriorated, capital escape will increase, therefore increasing the supply of AUD. At the present, involvement rates are at low degrees, nevertheless they are expected to lift in the close hereafter as economic assurance and growing are comparatively high. This means there will non be a big addition in the supply of Australian dollars.

Monetary value Expectations

Speculators and investors in the foreign exchange market who expect the value of the AUD to diminish will sell AUD so as to understate losingss. This will increase the supply of AUD and contribute to the awaited depreciation.

The domestic demand for imports

Australian importers who buy from abroad demand to sell AUD in order to obtain foreign currencies to pay for the imports. The degree of domestic income will mostly find the demand for imports. When the domestic economic system is turning, end product employment and income are lifting, so the demand for imports will besides lift which will so increase the supply of AUD. If people have more income they may take to buy goods from abroad which are considered to hold? prestigiousness? .

The domestic rising prices rate and fight of domestic houses that are in competition with imports will besides act upon the degree of demand for imports. If Australia? s domestic rising prices rate is higher and its houses are comparatively uncompetitive, so imports will be cheaper than merchandises produced in Australia and demand for imports will lift.

Besides, gustatory sensations and penchants of Australian consumers change over clip, and an addition in the desirableness of goods and services produced overseas will increase supply of AUD on the foreign exchange market.

When supply of the dollar additions, there is by and large a depreciation of the value of the currency.

THE GOVERNMENT ROLE IN THE EXCHANGE RATEThe authorities can? pull off? the Australian currency through the Reserve Bank of Australia ( RBA ) . The RBA can step in in the Foreign Exchange Market and can implement authorities policies designed to act upon the value of the dollar.

Reserve Bank Intervention in the Forex Market

The Australian exchange rate is by and large allowed to drift? flawlessly? , with market forces finding its value. However, from clip to clip, the RBA intervenes in the foreign exchange market to act upon the value of the exchange rate, therefore? soiling? the float. Intervention may take topographic point for a assortment of grounds. They are:

1. If the exchange rate perverts excessively much from its smooth long-term equilibrium way, there can be inauspicious effects on economic conditions such as rising prices, employment degrees and Gross Domestic Product.

2. Intervention ( as a purchaser or marketer of foreign exchange ) may assist to smooth the sentiment in the foreign exchange market ensuing from inordinate guess.

3. RBA governments may besides step in to forestall inordinate depreciation ( which could take to higher input monetary values and rising prices ) , or inordinate grasp ( taking to higher export monetary values and a loss of international fight ) and purchase clip to re-evaluate economic policy.

Government Policies Relating to the Exchange Rate

Basically, there are three policies that the Australian authorities ( through the RBA ) can make to seek and impact the value of the exchange rate under a natation system:

The RBA can step in straight in the force market as a purchaser or marketer of foreign exchange. This is normally done to smooth out the market to cut down what is deemed to be inordinate vola

tility caused by misinformed guess.

The RBA may step in indirectly by altering the degree of involvement rates through its market operations. This will hold the consequence of changing the involvement rate? derived function? between Australia and the remainder of the universe. A rise in involvement rates relative to overseas will promote capital influx and hence addition demand for the Australian dollar. This action might besides be taken to forestall farther depreciation of the Australian dollar. A autumn in Australian involvement rates will promote capital escape and increase the supply of Australian dollars relative to the demand. This action would forestall farther grasp of the Australian dollar.

The authorities may utilize a mix of macro-economic policies to increase or diminish the rate of economic growing in Australia relation to the remainder of the universe. Contractionary pecuniary, financial and industrial dealingss policies may cut down aggregative demand, including the demand for imports, thereby raising the value of the exchange rate. Alternatively, the usage of expansionary macro-economic policy would be expected to hike aggregative demand, including the demand for imports comparative to exports, raising economic growing, but take downing the exchange rate.

Direct intercession

Direct intercession by the RBA in the foreign exchange has possible deductions for domestic liquidness. Intervention by the RBA can be? sterilised? to countervail the effects on domestic liquidness and involvement rates or? unsterilised? with intercession impacting domestic liquidness and involvement rates.

Sterilization occurs when the RBA offsets its foreign exchange market intercession by purchasing or selling the tantamount sum of authorities securities, go forthing the pecuniary liabilities of the RBA unchanged.

Unsterilised foreign exchange market intercession involves no countervailing purchase or sale of authorities securities. An unsterilized sale or purchase of foreign currency will take to a autumn or rise in the money supply and a rise or autumn in involvement rates.

The RBA has ever undertaken sterilised intercession. There are two agencies of making this:

Buying Commonwealth Government Securities in its domestic operations

Arranging a foreign currency barter, by interchanging one currency for another in the current ( Spot ) market and holding to change by reversal the dealing at a hereafter day of the month at an in agreement monetary value or exchange rate ( hereafters market )

Indirect intercession

Monetary policy enterprises are a more indirect manner of act uponing the exchange rate, and are seldom used for this intent. If the authorities wishes to control rapid depreciation, it may increase the demand for AUD by raising involvement rates. Higher involvement rates will pull more foreign nest eggs, which must be converted into AUD. This will increase demand for AUD and set upward force per unit area on the exchange rate, nevertheless, this policy will by and large merely be effectual for a limited clip. It is unusual for the RBA to alter involvement rates in response to motions in the currency because the primary focal point of its pecuniary policy determinations is to act upon the domestic economic system. Sometimes the exchange rate motions are so big that they may impact the stableness of the economic system or the degree of rising prices. An illustration of this go oning occurred in April 2000. The RBA stated that one of the factors motivating it to raise involvement rates was the depreciation of the Australian dollar, which was adding to inflationary force per unit areas and seting low rising prices at hazard. This was the first clip since 1986 when the RBA had openly adjusted involvement rates in response to motions in the exchange rate.

THE EFFECTS OF EXCHANGE RATE MOVEMENTSBoth depreciation and grasp of the value of the Australian dollar have negative and positive effects. If depreciation occurs it raises the domestic monetary value of foreign goods every bit good as cut downing the foreign monetary value of exports. If grasp occurs, it lowers the domestic monetary value of foreign goods and raises the foreign monetary value of exports.

DEPRECIATIONThe depreciation of Australia? s currency has a figure of positive effects. They are:

In the long term, a depreciation of the exchange rate enhances the fight of the tradable goods sector ( manufacturers that compete with exports and imports ) by doing Australian goods and services cheaper and therefore more competitory relating to the same goods and services produced overseas. This will assist to raise export income and cut down import outgo. Overall this will assist to better the Current Account Deficit ( CAD ) . This theory is known as the theory of the? J Curve? .

A depreciation may promote higher degrees of capital influx into Australia as domestic assets become inexpensive relation to their foreign counter-parts. This can assist to cut down the degree of foreign debt and increase foreign equity investing in Australia.

A depreciation can take to a structural alteration in the makeup of the Australian economic system e.g. a displacement to the fabrication and services export industries.

Along with the above-named positive effects, there are besides negative effects. These are:

A depreciation of the currency can raise the cost of imports and cut down the monetary value of exports in the short term. This can take to take down export volume income from the sale of a given volume of exports and raise the cost of a given volume of imports. Lower export income and higher import outgo in the short term will increase the size of the CAD.

A depreciation can frequently take to a higher rising prices rate. This will happen if pecuniary policy is unable to incorporate inflationary outlooks. Since the 1990? s micro-economic policies have been adopted to smooth out rising prices and do the economic system more flexible when covering with big currency dazes such as the 1997 Asiatic crisis. Examples of these policies include enterprise bargaining and the national competition policy.

An immediate impact of a depreciation in the dollar is to increase the value of the portion of the net foreign debt to which the value of the AUD has depreciated against. e.g. If the AUD depreciates against the so the subdivision of foreign debt to USA will increase in value.

A depreciation of the AUD will raise the? debt-servicing ratio. ? The debt-servicing ratio is the involvement refunds as a per centum of exports. Higher involvement refunds can take to a higher net income shortage and increase the size of the CAD

A big depreciation could take the RBA indirect intercession to back up the exchange rate by raising involvement rates. This can take to take down economic growing and investing therefore cut downing employment and domestic assurance degrees.

APPRECIATIONAs with depreciation, grasp has both negative and positive effects. Some of the positive effects include:

And grasp of the exchange rate lowers the costs of imports and increases the monetary value of exports in the short-run. This can take to a higher export income and lower export outgo. This will take to a decrease in the size of the CAD.

Appreciation may take to take down domestic rising prices rates due to the lower import monetary values. This should raise the existent income of consumers who can so in return addition criterions of life by being able to buy a assortment of imports at a cheaper monetary value.

An grasp will cut down the value of the subdivision of foreign debt to which the currency has appreciated. If the value of the AUD rises comparative to, Australia? s foreign debt to the USA will diminish.

An grasp will cut down the debt-servicing ratio. Lower involvement refunds can take to a higher net income shortage and diminish the size of the CAD.

The negative effects of an grasp of the currency are as followed:

In the long term it will diminish the fight of Australian manufacturers in the tradable goods sector. Australia? s goods and services will go less monetary value competitory and hence less attractive to abroad purchasers. The CAD would increase if this were to happen.

An grasp could take to higher degrees of capital escape from Australia. This is because Australian assets become more expensive and less attractive relation to goods and services produced overseas. This would diminish foreign equity investing in Australia.

It could take to higher unemployment rates as those industries that export restructure in an effort to stay internationally competitory.

A dramatic grasp might take to a RBA indirect intercession to back up the exchange rate by take downing involvement rates to cut down the demand for Australian dollars. This could take to high degrees of economic growing and investing, doing domestic rising prices degrees to lift.

Recent Tendency IN THE AUSTRALIAN DOLLARIn recent months, the Australian dollar has by and large been doing an upward ascent. The tendency seems set to go on. Four months ago, the AUD was merchandising at.51715 ( 18/2/2002 ) . Today it is merchandising at.54795. The exchange rate is presently seen to be comparatively undervalued due to the strength of the American dollar. The Sydney Morning Herald? s Economic Editor, Ross Gittins, says that the American dollar is immensely overvalued and the Australian dollar undervalued. He says this is an instability and that? the thing about instabilities is that they? rhenium unsustainable: finally they have to be, and will be, corrected? one manner or the other. ? It could be for this ground that the Australian dollar is get downing to derive impulse and addition in value against all other major currencies, peculiarly the.

Other grounds for the grasp of the Australian dollar include the recent economic figures posted by the authorities demoing Australia to be in a strong economic place, the recent budget shortage and the awaited rise of involvement rates.

Bibliography: Shaw Stockbroking? Egoli? : hypertext transfer protocol: // Bank of Australia: hypertext transfer protocol: // Foreign Exchange Market: hypertext transfer protocol: // Bureau of Statistics: hypertext transfer protocol: // Economic Data: hypertext transfer protocol: // Treasury Website: hypertext transfer protocol: // Sydney Morning Herald Newspaper

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