Exchange Rates Flashcards
Exchange rate
Price of one currency in terms of another
Why do we have exchange rates?
Necessary to convert currency when trading, countries can’t use each other’s currency
TWI
Determines changes in a currency’s value against its main trading partners, weighted by percentage trade conducted with country
Forex market
Where currency is traded
Appreciation
Price increase in terms of another currency
What is the target exchange rate?
Stable,
Causes of depreciation
Decreased demand/increased supply of AUD
Causes of decreased demand for AUD
Decreased exports, income credits, capital inflow
Fall in ToT, interest rate differential
Higher relative inflation
Effect of depreciation
Decreased price of Aussie exports Increased price of imports Improved national competitiveness Net exports increase → trade balance Boost economic activity
Causes of increased supply of AUD
Increased imports, income debits, capital outflow
Fall in interest rate differential
Depreciation
Price of currency decreases in terms of another
World’s most traded currency
USD
Why is it inaccurate to compare AUD with USD?
Not main trading partners
3 ways to determine exchange rate
Floating, managed, fixed
Fixed
Value tied to other currencies, central authority guarantees a certain exchange rate
Revaluation
Movement to a higher exchange rate for fixed
Devaluation
Movement to a lower exchange rate for fixed
Who is the central authority that might set the exchange rate?
Government, reserve bank
Managed exchange rate
Similar to free, allowed to find value within desired range, subject to intervention if outside said range
How would the currency be supported for a managed rate?
Central authority would buy the currency with foreign exchange
How would the currency be arrested for a managed rate?
Central authority would buy the foreign exchange with their own currency
Free/floating exchange
Price of currency determined by demand and supply
Strongest currency
GBP
How is demand of a currency determined?
Credits: exports, received income, foreign investment, capital inflow
How is supply of a currency determined?
Debits: imports, paid income, overseas investment, capital outflow
Relative inflation rate
Increased international competitiveness, exports, demand for AUD
Decreased imports, supply of AUD
Movements in ToT (ceteris paribus)
Increased terms of trade, exports receipts, demand for AUD
Decreased import payments, supply of AUD
Effect of floating exchange rate (BoP)
Equalise value of debits/credits
How does floating exchange balance BOP?
Matching surplus, demand/credits = supply/debits
Quantitative easing
Creating more of a country’s currency
