Ex rates Flashcards
Theory definition
The exchange rate is the price of Australia’s currency in terms of another countries currency. There are three types of exchange rate systems, a fixed exchange rate, a managed flexible peg rate and a floating exchange rate. The Australian Dollar was floated by the government in December 1983 and is now determined by the forces of supply and demand for the AUD in the foreign exchange market as seen in the graph below.
Demand and Supply + GRAPH
DO A LITTLE GRAPH HERE
Demand for the AUD will be affected by financial flows into Australia as investors need to convert currency into AUD, expectations of future movements, and demand for Australian exports. These factors will shift the demand curve between D1 and D2, appreciating the sum from P2-P3, supply stays at S.
Supply factors for the AUD include, the level of financial flows out of Australia, Speculators, the domestic demand for imports, and tastes and preferences. This will increase the supply curve in the diagram above from S1-S2 depreciating the sum from P3-P1, demand stays at D.
Movements in recent years
The Australian dollar experienced a sustained appreciation during the first decade of the 21st century, and then a trend depreciation in the second decade. After hitting a low in 2001 (of US47 cents), from 2003 it began appreciating strongly as commodity prices increased. The A$ fell sharply in 2009 as the global financial crisis destabilized international currency markets, losing one third of its value against the US dollar. But its swiftly recovered, peaking at US$1.10 and 79 on the TWI in 2011. The A$ then began to depreciate, falling during the mid-2010s into a range between US70-80 cents. With domestic interest rates falling to record lows and anxiety about the US triggering a global trade war, in 2020 the currency depreciated to just above US60 cents and then back up after the outbreak of COVID to US0.72 cents
impact on individuals
The impact of the depreciation of the dollar varies for individuals depending whether they are consumers or employees. Australian consumers have suffered reduced purchasing power due to a weaker Australian dollar compared to overseas currencies, however depreciations also increase the value of foreign assets in Australian dollar terms raising the wealth of Australian investors.
Individuals as employees experience higher wage growth and employment in export industries as Australian firms gain a competitive advantage from a weaker dollar increasing demand for Australian exports.
impact on government
For the government, the depreciation has varying impacts. The positive impact on employment means that government is able to reduce spending on social welfare and the increase in growth of exporting and import competing industries means an increase in taxation revenue for the government. As a result of a weaker dollar, the government experiences higher interest serving costs as Australia can buy less foreign currency with which to pay interest. The “valuation effect” will raise the AUD level of foreign debt that has been borrowed in foreign currency as expressed in Australian dollar terms, as well as this inflationary pressure will increase as imports will now would now be more expensive.
impact on businesses
Similarly, firms and business are impacted differently depending on their structure. Exporting industries especially those with few import inputs such as dairy, or wheat experience increased growth from foreign countries who can now buy Australia’s exports at a comparatively cheaper price. As well as this import competing industries also experience growth as they gain a competitive advantage against imports. On the contrary firms that rely on heavy import components will suffer as they have to pay more for imports, examples of an industry that will be negatively affected by this depreciation is the mining industry who rely on importing capital machinery, and whose exports are relatively inelastic.
