Exchange RatesExchange Rates

• The value of one countryThe value of one country’’s currency in s currency in terms of another countryterms of another country’’s currency.s currency.

• 1983 Australia changed to a flexible 1983 Australia changed to a flexible exchange rate (floating exchange rate)exchange rate (floating exchange rate)

• Forces of demand and supply on FOREX Forces of demand and supply on FOREX (foreign exchange) markets determine (foreign exchange) markets determine the exchange rate.the exchange rate.

Trade weighted IndexTrade weighted Index

• Measures movements in the exchange rate compared to major trading partners• Over the last 5 years the AUD has been appreciating relative to the US$ + TWI• Graph the AUD relative to the US$ and TWI over the last 8 years – page 135• what is the AUD exchange rate today?

DepreciationDepreciation

• decrease in value of currencydecrease in value of currency• $1AUD= $1US$1AUD= $1US• $1AUD=$0.90 US$1AUD=$0.90 US• Why does a depreciation occur?Why does a depreciation occur?• Use demand and supply diagramsUse demand and supply diagrams

Depreciation – positive Depreciation – positive effectseffects

• Increase international competitiveness – export Increase international competitiveness – export prices can fall and import prices can rise. The prices can fall and import prices can rise. The impact of this will depend on the price impact of this will depend on the price elasticity of demand for exports and imports. elasticity of demand for exports and imports. WHY? WHY?

• CAD should improve if X growth increases.CAD should improve if X growth increases.• Encourage foreign investment Encourage foreign investment • Increased economic growth rates.Increased economic growth rates.

Depreciation – negative Depreciation – negative effectseffects

• Increases interest servicing costs for funds borrowed Increases interest servicing costs for funds borrowed from overseas- valuation effect - increases CADfrom overseas- valuation effect - increases CAD

• Increases the Foreign debt in AUD for those that have Increases the Foreign debt in AUD for those that have borrowed from overseas – valuation effectborrowed from overseas – valuation effect

• Increased domestic inflation as import prices increase.Increased domestic inflation as import prices increase.• A large and sudden depreciation may prompt RBA A large and sudden depreciation may prompt RBA

intervention.intervention.

NOTE: an appreciation has the opposite positive and NOTE: an appreciation has the opposite positive and negative effects negative effects

AppreciationAppreciation

•What is an appreciation?

•Why do currencies appreciate?

•What are the positive effects?

•What are the negative effects?

SummarySummary

• Overall a depreciation is generally Overall a depreciation is generally considered good by exporters considered good by exporters because it increases international because it increases international competitiveness and bad by those competitiveness and bad by those that have borrowed from overseas that have borrowed from overseas or are travelling overseas.or are travelling overseas.

Role of RBARole of RBA

• RBA intervenes in FOREX markets from RBA intervenes in FOREX markets from time to time to stabilise the currency- time to time to stabilise the currency- this is called dirtying the float. this is called dirtying the float.

• DirectDirect RBA intervention can only be a RBA intervention can only be a short-termshort-term

• RBA intervention can also be RBA intervention can also be indirect indirect via via domestic interest ratesdomestic interest rates

Fixed or Managed Fixed or Managed exchange ratesexchange rates

• Some countries attempt to manage Some countries attempt to manage their exchange rates- Singapore their exchange rates- Singapore and Chinaand China

• The central bank buys or sells The central bank buys or sells currency to maintain stability in the currency to maintain stability in the marketmarket

• Managed currencies tend to Managed currencies tend to discourage currency speculatorsdiscourage currency speculators

RevisionRevision

• Complete the multiple choice and Complete the multiple choice and short answer question.short answer question.

• Complete questions 1-10 from text Complete questions 1-10 from text page 143page 143

• Discuss the effects of an Discuss the effects of an appreciation of the Australian appreciation of the Australian dollar on Australia’s internal and dollar on Australia’s internal and external stability. external stability.