Exchange Rates Flashcards
Exchange rates
The price of a currency expressed in other currencies
- Sale and purchase of foreign currency is called “foreign exchange”
Why does the FX grow fast?
- Growth of international trade
- Technology
- Government deficit
- Securitisation
Why do exchange rates matter?
Changes in the price of imports and the payment received from exports.
- If AUD appreciates:
- The price of exports increases (less competitive)
- The price of imports decreases - If AUD depreciates:
- The price of exports decreases (more competitive)
- The price of imports increases
Measuring exchange rates
Bilateral: compares the value of currencies of two economies
Trade Weighted Index (TWI): a single number representing the strength of the AUD compared to other major trading partners
Trade weighted index
The weighted average value of the AUD in relation to a “basket” of currencies of Australias key trading partners (according to their importance in our trade)
If TWI improves then AUD is stronger against its trading partners
Currency:
- Appreciation
- Depreciation
Appreciation: increase in the value of currency relative to another currency
Depreciation: decrease in the value of currency relative to another currency
Floating exchange rate system
Where the value of a currency depends solely on the market forces of supply and demand.
Pros: allows for the economy to adjust to undesirable trends
Cons: as currency can be freely traded, it can be vulnerable to speculators
- no guarantee that exchange rates will be stable
- Volatility may be detrimental to attracting foreign investment
Floating exchange as “automatic stabiliser”
- Boosts economy in case of economic slowdown
- Smooths economic systems
economics slowdown - AUD depreciation - promotes exports and foreign exchange - economic recovery - AUD appreciates - slowdown exports and foreign exchange - economic slowdown
Fixed exchange system
Where the value of a currency is determined by the government, who fixes it to the value of another currency.
To maintain local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which is fixed.
Pros: trade is predictable
Cons: limits monetary policy independence due to restricting the use of interest rates
- requires the monetary policy authority to hold substantial foreign currency reserves for intervention purposes
Managed exchange system
Where the central bank may choose to intervene in the foreign exchange market to affect its value
Pros: attempts to manage shocks and make country more competitive
Cons: currency becomes key focus for the monetary policy with manipulation of currency not approved by international trading partners
Floating exchange: Increase supply (sell)
Causes:
Increase in…
- Imports
- Australians travelling overseas
- Investing overseas
- Repaying overseas loans
- Investment income from overseas investment
Results in:
- price of AUD decreases (weaker)
DEPRECIATION of AUD
Floating exchange: Decrease supply (sell)
Causes:
Decrease in…
- Imports
- Australians travelling overseas
- Investing overseas
- Repaying overseas loans
- Investment income from overseas investment
Results in:
- price of AUD increases (stronger)
APPRICIATION of AUD
Floating exchange: Increase demand (buy)
Causes:
Increase in…
- Exports
- Overseas people travelling to Australia
- Investment in Australia
- Borrowing from Australia
- Investing in Australia to benefit from stronger interest rates
- Investment income made overseas to Australia
Results in:
- price of AUD increases (stronger)
APPRECIATION of AUD
Floating exchange: Decrease demand (buy)
Causes:
Decrease in…
- Exports
- Overseas people travelling to Australia
- Investment in Australia
- Borrowing from Australia
- Investing in Australia to benefit from stronger interest rates
- Investment income made overseas to Australia
Results in:
- price of AUD decreases (weaker)
DEPRECIATION of AUD
