Exchange Rates Flashcards
What is Exchange Rates?
The value of one country’s currency in terms of another countries currency.
What is the difference between a floating exchange rate and a fixed/pegged exchange rate?
Floating - value is determined by market forces of supply and demand (Aus use).
Fixed - value of the currency is fixed/pegged to the value of another and therefore it’s movements follow the currency it is pegged to (instead of supply and demand).
Determine the causes/effects of an appreciated exchange rate.
An increase in the value of the currency (AUD).
Caused by increase D for Aus dollar.
- Increased export demand: Increased X demand = Increased D for AUD to pay for X = appreciation
- Increased commodity prices: Increased D for AUD to cover the rise in commodity price = appreciation
- Increased foreign investment into Australia = Increased D for AUD = appreciation
Determine the causes/effects of a depreciated exchange rate.
A decrease in the value of the currency (AUD).
Caused by an increased supply of AUD/decreased D for the Aus dollar.
- Increased import demand: Australians need to exchange AU for other currencies = trying to get rid of AUD = increased supply of AUD in the exchange market = depreciation
- Increased foreign investment from AUS to overseas = Australians need to exchange AU for other currencies = trying to get rid of AUD = increased supply of AUD in the exchange market = depreciation
- Increased income receipts from Australia to overseas = Australians need to exchange AU for other currencies to pay overseas people in their local currency = trying to get rid of AUD = increased supply of AUD in the exchange market = depreciation
What is the Trade Weighted Index?
An index that adds up a basket of currencies (each weighted based on trade importance)
TWI is very similar to the exchange rate (increases/decreases in the TWI are the same as increases/decreases in the AUD).
Better compares whether the AUD is rising/falling compared to our trading partners/shows if movements in the exchange rate are caused by changes in our economy.
Demonstrate the impacts of change in factors that affect the exchange rates.
Relative Inflation - High relative inflation = AUS prices are less internationally competitive = reduced export demand = less demand for the AUD = depreciation. Vice versa for appreciation.
TOT - Fall in the terms of trade = decrease in export prices compared to import prices = decreased demand for the AUD = depreciation. Vice versa for appreciation.
dEGR - Strong domestic economic growth = higher incomes / local investment = higher import spending = increased supply for the AUD = depreciation. Vice versa for appreciation.
wEGR - Falling world growth = reduced export spending = decreased demand for the AUD = depreciation. Vice versa for appreciation.
Relative interest rates - Low relative interest rates = less attractive for foreign investors to invest in AUS/ more attractive for Australians to invest overseas = less demand and increased supply of AUD = depreciation. Vice versa for appreciation.
How is the exchange rate related to the balance of payments?
Depreciation -> Increase in Trade Balance in Current Acc of BOP:
X becomes int. comp. and M becomes more costly - trade balance recorded a rise in trade surplus/fall in the trade deficit as more X credit - less M debits.
Appreciation -> Decrease in Trade Balance in Current Acc of BOP:
X becomes less int. comp. and M become cheaper - trade balance recorded as a fall in trade surplus/rise in the trade deficit as more M debit - less X credit.
Who are the winners and losers of specific types of exchange rates?
Appreciation:
‘Winners’ - Consumers: cheaper imports (cheaper to buy from overseas/travel to overseas) - Importing businesses: cheaper foreign goods costs - better margins
‘Losers’ - Exporting industries: less competitive prices lead to lower export demand - Import competing producers (cheaper for people to buy imports than buy local).
Depreciation:
‘Winners’ - Exporting industries: more competitive prices increases X demand - Import competing producers (cheaper for people to buy from them than to import).
‘Losers’ - Consumers: more expensive to buy imports -Importing businesses: higher goods costs - lower margins - Australians travelling overseas
Name a few recent trends in the exchange rate.
2018: 0.75-0.78 — Slight rise / stable as commodity prices rise + stabilise
2019: 0.70 — Fall in AUD back to 0.70. Due to multiple causes - slightly less X demand and a rise in US interest rates making it more attractive to invest in USD then AUD.
2020: Corona Virus?
What is the balancing effect of the exchange rate?
If we experience high export demand and this leads to an appreciation. This exchange rate movement (appreciation) will make exports less competitive and lead to a fall in export demand. So the effect (less export demand) has in a way ‘neutralised’ the cause (high export demand).
Helpful as it smooths out economic fluctuations.
