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:
Export of goods and services
Current income and transfers to Australia from abroad
Capital and financial inflows (investments)
Supply of the Australian dollar is determined by:
Import of goods and services
Current income and transfers from Australia to abroad
Capital and financial outflows
Other factors contribute to short and long term changes in exchange rates including:
Changes in prices of exports
Changes in prices of imports
Expected future value of the currency
Structural changes that alter comparative advantage
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.