Exchange Rates Flashcards
1
Q
Trade Weighted Index
A
- Basket of currencies weighted according to their importance in trade flows with Australia
2
Q
Exchange Rate
A
- The price of one country’s currency in terms of another country’s currency
3
Q
Foreign Exchange Market
A
- Market in which the currencies of different countries are bought and sold.
- > Between two groups, those demanding U.S. dollars and those demanding AUD.
- -> importer of U.S. = demand U.S dollars
- -> ImportING U.S. = demand AUD
4
Q
Foreign Exchange
A
- Currency of another country that is needed to carry out international transactions.
5
Q
If Australians were to increase their imports from the US
A
they will supply more Australian dollars and demand more American dollars
- > Supply curve of $AUD will increase (shift right)
- > Demand curve of $US will increase (shift right)
- > $AUD will depreciate and $US will appreciate
6
Q
Exchange Rates and B.O.P.
A
- All transactions recorded as credits = demand for a countries currency
- All transactions recorded as debits = supply of a countries currency
7
Q
Two basic methods of determining the price of a country’s currency
A
- Market forces of supply and demand to set value
- Artificially setting the price at a fixed rate
8
Q
Floating Exchange Rate
A
- One whose values is determined by the market forces of supply and demand.
- > Equilibrium price will change whenever demand or supply curves shift.
- total BOP will balance.
- Known as a clean float.
9
Q
Managed Exchange Rate
A
- Occurs whenever there is official intervention in the foreign exchange market by RBA
- Can act as either buy or seller, indirectly influencing its rate.
- Monetary Policy
- > short term interest rates
- > increase in interest rates, F.I. increases, demand for AUD increases
Known as a dirty float
10
Q
Free Exchange Rate and B.O.P.
A
- Shortages and surpluses are avoided
- > Advantage of providing automatic adjustment in the B.O.P.
- > e.g. excess supply of AUD, depreciation will raise price of imported goods and services in DOMESTIC CURRENCY
- > lower the prices of exported goods and services in foreign currencies
- -> automatically help reduce excess supply.
- Does not affect domestic money supply
- > is highly desirable
- > monetary policy is more effective
- Helps reduce swings in C.A.B.
- > Rise in CAD lead to exchange rate depreciation
- > Increases price of imported g.s
- > decreases price of exported g.s
- > demand for imports fall
- > demand for exports increased therefore reducing a current account deficit.
- Can help insulate domestic economy from external shocks
- > depreciation can shield from negative shock
- > reduces price of exports, provides competitive advantage
- > expansionary effect therefore insulate from recession
- appreciation can shield from positive shock
- > increased economic growth in china and india boost world commodity prices
- > mining boom increased investment and income
- > normally leads to high inflation but actually slows economy by inducing export prices and reducing import prices
11
Q
Movements in Exchange Rate
A
- Exchange rate appreciation will occur if demand for currency increases or supply of currency decreases
- > If credit items in Australia’s balance of payments (exports and capital inflow) increase,
- > Demand for Australian dollars increase
- > Demand ($AUD) curve shifts right
- > Currency appreciates
- Exchange rate depreciation will occur if demand for currency falls and supply of currency increases
12
Q
Summary for currency appreciation
A
causes:
- Increase in demand ($AUD)
- > Increase exports
- > Increased income credits
- > Increase capital inflow
- > Higher terms of trade
- > Higher interest rate differentials
- > Lower relative inflation
- > Improvement in international competitiveness
- Decrease in supply ($AUD)
- > Decreased imports
- > Decreased income debits
- > Decrease capital outflow
- Effects
- > Price of Australian exports increases
- > Price of imports falls
- > Net exports will decrease increasing trade deficit and CAD
- > AD decreases
- > Inflation falls from lower import prices
13
Q
Factors affecting exchange rate
A
- Relative inflation rates
- > Inflation reduces the competitiveness of industries in the traded goods sector
- > High inflation rate relative to other countries is likely to have a downward influence on exchange rate
- Movements in terms of trade
- > Major influence on Australia’s exchange rate
- > When terms of trade improves, currency appreciates
- Domestic economic growth
- > Strong economic growth in Australia will lead to an increase in demand for imports, both investment and consumption goods
- > This results in currency depreciation
- World economic growth
- > Australia is a major exporter of commodities such as minerals and energy resources
- > A pickup in world economy increases the demand for these goods which increases commodity prices and the demand for $AUD which results in a currency appreciation
- Relative interest rates (Interest rate differential)
- > If interest rates are higher in Australia, foreign investment will increase which appreciates currency
- International capital flows
- > If investors found Australia to be a relatively more attractive destination for their funds compared to other economies, then the Australian dollar will appreciate
14
Q
Key factors affecting Australia’s exchange rate
A
- Commodity prices
- > 70% of Australia’s exports are made up of primary commodities
- > Changes in prices of commodities have a significant effect on export values and ultimately on Australia’s national income
- Australia’s interest rate differential with the US
- > Measured by difference in official cash rates between two countries
- > Interest rate differential attracts foreign investors
- > International investors seek out the highest returns for their funds
-> -> An increase in interest rate differential, ceteris paribus, will lead to an inflow in foreign investment into Australian economy, increasing demand for $AUD and appreciating the currency
15
Q
Effects of exchange rate movements : depreciation
A
-> bestows a competitive advantage through relative price effects on exports and imports
-> Prices of Australian goods and services in foreign currency (Australia’s exports) fall while prices of overseas
goods and services (Australian imports) in Australian currency rise
- > increase exports and decrease imports, increasing AD
- > work to reduce a trade deficit (or increase trade surplus) and a CAD
- > Depreciation is good news for Australian exporters and domestic producers who compete against imports
- > hurts consumers since they must pay higher prices for imported goods
- > Depreciating currency is also potentially inflationary because higher priced imports feed into consumer price index and increase net exports which boosts national income, thus boosts AD
