What is the Exchange Rate? Represent the price of one nation’s currency in terms of another nation’s currency. Eg. Exchange $1500 Australian for US currency, where $1 AUS buys 65 cents in US currency = $US975.
Setting the Exchange Rate Countries choose different ways of setting their currency’s exchange rate:-
Fixed Exchange Rate Exchange rates are set by a country’s government or central bank.
Flexible or Floating Exchange Rate Exchange rates are set by the interaction of the forces of demand and supply in the foreign exchange markets.
Managed Exchange Rate Exchange rates are established by forces of demand and supply in foreign exchange markets but with intervention by central banks on occasions.
Australia has a floating currency – Price in terms of other currencies changes throughout the day in response to supply and demand. Australia’s Exchange Rate
The Australian dollar is currently the sixth-most-traded currency in world foreign exchange markets (behind the euro, US dollar, the yen, the pound sterling, and the swiss franc), accounting for over 6% of worldwide foreign-exchange transactions. The Australian dollar is popular with currency traders due to high interest rates in Australia, the relative freedom of the foreign exchange market from intervention by the Australian government, the general stability of the economy and political system, and the prevailing view that it offers diversification benefits in a portfolio containing the major world currencies (especially because of its greater exposure to Asian economies and the commodities cycle). In the inter-bank foreign exchange market AUD/USD is known simply as the "Aussie".
Demand for the Australian dollar is determined by: <ul><li>Export of goods and services </li></ul><ul><li>Current income and transfers to Australia from abroad </li></ul><ul><li>Capital and financial inflows (investments) </li></ul>
Supply of the Australian dollar is determined by: <ul><li>Import of goods and services </li></ul><ul><li>Current income and transfers from Australia to abroad </li></ul><ul><li>Capital and financial outflows </li></ul>
Other factors contribute to short and long term changes in exchange rates including: <ul><li>Changes in prices of exports </li></ul><ul><li>Changes in prices of imports </li></ul><ul><li>Interest rates </li></ul><ul><li>Expected future value of the currency </li></ul><ul><li>Structural changes that alter comparative advantage </li></ul>
How is the Exchange Rate Measured? There are two common ways of measuring Australia’s exchange rate:-
Individual Exchange Rates The A$ has a separate exchange rate for every currency in the world including the rate for US dollars etc. Cross rates tell how many currency units for each country can be purchased with one A$.
Measures the average changes in the Australian dollar against a basket of different currencies of our major trading partners. Being an index, a base year of 100 points is used (for Australia this is 1970) to compare changes in the currency’s value in subsequent years. Trade Weighted Index
Depreciation Depreciation occurs when demand for the Australian dollar is less than its supply and as a result the Australian dollar decreases in value relative to another currency.
What does this mean? <ul><li>Exports are cheaper for foreign buyers. </li></ul><ul><li>Importers pay more for goods and services. </li></ul><ul><li>Investment in Australia is more attractive. </li></ul>
Appreciation Appreciation occurs when demand for the Australian dollar is greater than its supply and as a result the Australian dollar increases in value to another currency.
What does this mean? <ul><li>Exports are more expensive to foreign buyers. </li></ul><ul><li>Importers pay less for their goods and services. </li></ul><ul><li>Investments are less attractive. </li></ul>Glue in the supply and demand diagram
<ul><li>Averaged only around 57 points on a trade-weighted basis (against 100 points in the base year of 1970) </li></ul><ul><li>Tended to depreciate overall in terms of the TWI in the base year, as well as against most individual exchange rates (eg. US dollar, Japanese Yen, NZ dollar). </li></ul>Trends – Australian Dollar
Market Forces and their influence on trade and international capital flows Capital Flows – Foreign Investment to and from other countries.
Trends in Capital Flow <ul><li>In the 1950’s and 60’s, most foreign investment in Australia was from the UK. </li></ul><ul><li>In 2005/06 the main source of investment funds include the US, UK, Japan, Singapore and other parts of Asia. </li></ul><ul><li>Australia has increased the investment in Europe and the US, as well as China, Malaysia and Vietnam. </li></ul>
Advantages of Capital Inflow <ul><li>Provides access to new technology and production methods </li></ul><ul><li>Offsets the large CAD </li></ul><ul><li>Increase efficiency in production, lift the rate of economic growth, creates more jobs </li></ul><ul><li>Increased tax to Australian government </li></ul>
Disadvantages of Capital Inflow <ul><li>Large amounts of interest are paid abroad to foreign investors leading to a larger CAD </li></ul><ul><li>Some of our country’s assets are now owned and controlled by foreigners. </li></ul>
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