econs Exchange Rates and Foreign Investment Task 3 Flashcards
Define exchange rates
the price of one country’s currency in terms of another country’s currency
What is the FOREX market?
- foreign exchange market
- determines the price of a currency which brings together buyers and sellers of foreign currencies
What is TWI?
- Trade Weighted Index
- a common measure of AUD
- measures the movement of the AUD against a basket of currencies weighted according to their importance of trade with Australia
What is appreciation?
the price of one country’s currency increases against another country’s currency
What is depreciation?
the price of one countrys currrency decreases against another country’s currency
What is the price of a currency subject to?
changes tp the demand and supply of a currency
What is Demand determined by?
(buyers of currency)
- determined by all credit transactions (Transaction which involve money entering the domestic economy)
What is supply determined by?
(sellers of currency)
- determined by all debit transaction (Transactions which involve money flowing out of domestic economy)
What happens to demand when there is an appreciation of a currency?
- increase in demand (↑CR)
due to - increase exports
- income income received
- increase capital inflow(FI)
What happens to supply when there is an appreciation of a currency?
- decrease in supply (↓DR)
due to - decrease imports
- decrease income paid
- decrease capital outflow(AIA)
What happens to demand when there is a depreciation of a currency?
- decrease in demand (↓CR)
due to - decrease exports
- decrease income received
- decrease captial inflow (FI)
What happens to supply when there is a depreciation of a currency?
- increase in supply (↑DR)
due to - increase imports
- increase income paid
- increase capital outflow (AIA)
What are the 8 factors affecting ER?
- domestic growth
- world growth
- world commodity prices
- ToT
- external shocks
- interest rate differential
- relative inflation rates
- level of domestic savings
What happens to ER when Domestic Growth decreases
- decreases output
- decreases income
- decreases import spending
- decrease in supply
- ER appreciates
What happens to ER when world Growth decreases
- fall in growth from trading partners
- decrease income and spending
- decrease demand for exports
- FI decreases as countries have less funds to invest
- ER depreciates
What happens to ER when there’s a fall in commodity prices
- export revenue decreases
- demand for AUD decreases
- ER depreciates
What happens to ER when there is unfavourable TOT
- export prices fall relative to import prices
- export revenue falls relative to import payments
- more money going out, increases supply
- ER depreciates
What happens to ER when there is relatively high inflation?
- fall in international competitiveness
- decrease demand for exports = decrease demand = DEP
- increase demand for imports = increase supply = DEP
What happens to ER when theres a fall in interest rate differentials
SHORT TERM:
- aus IR lower than major trading partners -> decrease in FI due to lower rate of return -> decrease in D for aud -> dep
- AIA increases as Australia investors attracted to higher rates of return offered outside of AUS-> increase M spending -> increase in S -> dep
LONGTERM:
- causes FI decreases -> decrease PI debit -> decrease in S for AUD-> app
- AIA increases ->PI CR increase -> increase In D for aud -> app
What happens to ER when lvl of domestic savings increase
- more domestic funds for investment
- decrease D for FI ->decrease D for aud
- depreciate
- increase in domestic funds for I -> increase in AIA -> increase S -> dep
What are the effects of a depreciation on international competitiveness and X+M?
-export competitiveness increases
- exports and revenue increase
- imports decrease as more expensive
- foreign currencies can buy more AUD with one unit of their currency
- exports more IC than export destinations
What are the effects of a depreciation on trade balance and CAB
- increade D for X -> G/S CR will increase
- decrease D for M ->G/S DR will decrease
- TB increases -> BOGS increases -> CAB inreases
What are the effects of a depreciation
on Foreign Investment flows
- FI increase as exports are cheaper
- AIA decreases as investing overseas is expensive
What are the effects of a depreciation on Domestic producers of EXPORTS:
- increase in D for exports will increase production
- increase in export revenue and profit
- increases employment in export sector
What are the effects of a depreciation
on Domestic Producers of import replacement goods?
- imports more expensive therefore domestic production will increase
- increase revenue and profit
What are domestic Producers of import replacement goods?
domestic prods of imported goods competing with overseas companies importing the same ood
What are the effects of a depreciation
on domestic consumers?
- Depreciation increases cost of imported goods therefore consumer wellbeing falls
- decreases consumer purchasing power
- ## will choose cheaper domestic alternative
What are the effects of a depreciation
on unemployment?
- increased employment in export sector eg mining industry
- as increase in D for exported expand the business and increases D for workers
- decrease in structural UE
-economy expands due to increased export revenue
- increase in AD and employment increases
- decrease in cyclical UE
What are the effects of a depreciation
on Growth?
- increase in econ growth as output and spending increase
What are the effects of a depreciation
on inflation?
- increased in AD causes inflationary pressure through an increase in demand - pull inflation
- cost of import capital increases -> increases cost of production - cost push inflation
What are the 5 winners and 5 losers of a depreciation
WINNERS:
- exporters
- domestic tourist industry
- workers gaining jobs in export industry
- economic growth might increase
- CAD should improve
LOSERS:
- consumers who buy imports
- resident who holiday abroad
- firms who buy imported raw materials
- those on fixed incomes/wages who see inflation rise faster
- foreign exports/ tourist industry
Definition of foreign investment?
overseas resident owning australia financial assets
What are foreign liabilities?
stock of australian financial assets owned by overseas investors either from buying Australian assets or lending of money to australia
Definition of Australian investment abroad?
australian resident owning foreign financial assets
What are foreign assets?
stock of foreign financial assets owned by Australia investors either from buying foreign assets or lending money abroad
What are foreign equity securities?
financial assets which result in ownership of an asset eg buying shares
What are foreign debt securities?
financial assets in the form of borrowing (loans) and does not result in ownership of an asset
What is direct investment?
- results in 10% or more ownership of an financial asset
- equity securities
What is portfolio investment?
- results in less than 10% ownership of a financial asset
- equity securities or debt securities
What is Govt borrowing and lending
debt securities
What is reserve assets
buying and selling of foreign currencies
What is the difference between Australia’s levels of Foreign Investment and Australian Investment Abroad?
FE + FD = FL
- - -
AEA + ADA = FA
= = =
NFE + NFD = NFL
Other terms for net foreign liabilites?
- Balance of financial acc
- net capital inflow
- Net International Investment Position (NIIP)
How does Foreign investment impact financial account and current account?
- FI recorded in financial acct as credit entry
- AIA recorded in financial acct as debit entry
- current acct records the service payments in the form of income from the investment
- FI will result in primary income debit
- AIA will result in primary income credit
- ↑FI -> ↑Primary Y DR -> ↓Net Y ->↓CAB
- ↑AIA -> ↑Primary Y CR ->↑Net Y ->↑CAB
What is risk sentiment?
how much risk investors are willing to take on in their investments
- If ER appreciates (as more FI comes in) = risk sentiment improves
Describe the Trends in Australia’s Foreign Investment (ten years)
- Net Foreign Liabilities, while remaining positive indicating FL>FA, is decreasing as Investment flows in Aus fall relative to investment flows coming out
- Net foreign Equity has fallen to negative % of GDP since 2013.
- indicating that Australian ownership of Foreign assets is greater than buying of aus assets by foreign residents (AEA>FE)
Explain the Trends in Australia’s Foreign Investment (ten years)
- increase in dom savings as aus experiences a SI gap since 2019, where by the supply of funds increases, therefore aus has more money to invest overseas
- aus govt is buying foreign assets in order to boost aus public savings as future funds to address to address aus ageing population
What are the 5 benefits of foreign investment (AS)
- Enables Australia to supplement its domestic savings in order to finance a higher level of investment (fills the I-S gap)
- Source of econ growth for both demand+ supply as it represents increasing firms expenditure + increases stock of physical capital = increases productive capacity of the economy
- Provides capital to finance new industries and enhance existing industries e.g. mining sector, which increases both employment and GDP
- Provides capital to finance new infrastructure in both the private and public sectors
- Higher levels of GDP increases tax revenues for both the federal and state governments, and increasing the funds available to spend on hospitals, schools and roads
What are the 6 costs of Foreign Investment?
- Negatively impacts current account through primary income debits.
- Increase in FI causes an appreciation of the AUD which can reduce international competitiveness
- Depreciates the AUD in the long-term – increase income payments (increase S in AUD)
- Can lead to debt trap where more money is borrowed to sustain debt
- Foreign ownership of aus assets (from FE) leads to increase in domestic structural UE due to shift in labour to where it is cheaper overseas/new tech
- May lead to increased demand inflation as spending in the economy increases
How to convert to different currencies?
1 AUD = 0.65USD
1/0.65 = 1.53 AUD
What are 2 reasons for an increase in commodity prices?
- increase in export revenue
- increase in FI as mining industries expand due to large demand for exports = more overseas investment to fund mining
calc percentae change in figures
Change/ OG x 100
