Exchange Rates: Basics

Question 1

What is the trade weighted index?

Answer 1

The TWI is an index that measures change in the AUD from 100 in a base year, relative to a basket of currencies weighted according to the value of trade that Australia makes with that country.

Question 2

Why is the TWI a more useful measurement of the AUD than a bilateral exchange rate?

Answer 2

TWI shows how the currency overall is measuring relative to the currencies that are most relevant to that economy, rather than just one specific currency

Question 3

What are 3 types of exchange rates?

Answer 3

1 .Fixed

2. Managed
3. Floating

Question 4

When did Australia float its exchange rate?

Answer 4

1983

Question 5

What is a managed exchange rate?

Answer 5

The government ensures that the exchange rate stays within a set band (i.e. a price ceiling and price floor)

Question 6

What is the main benefit of a fixed exchange rate?

Answer 6

Avoid volatility of the exchange rate to provide certainty for trade and investment

Question 7

What are 3 benefits of a floating exchange rate?

Answer 7

1. Acts as a shock absorber from changes in the global economy
2. Central bank does not need foreign reserves
3. Monetary policy can focus solely on controlling inflation

Question 8

What is the formula for the terms of trade?

Answer 8

(Export price index ÷ Import price index) x 100

Question 9

What does the terms of trade measure?

Answer 9

The ratio between changes in a country’s export prices and import prices. It shows changes in the volume of exports needed to purchase a consistent volume of imports

Question 10

What does an improvement in the terms of trade mean?

Answer 10

Australia can now purchase more imports than before with a set volume of exports

Question 11

How has Australia’s terms of trade changed over the past 20 years?

Answer 11

The ToT doubled between 2003-2013 during the mining boom; then fell once mine expansions around the world had been completed.

The ToT spiked again to be even higher than in the peak of the mining boom.

The ToT has fallen slightly since 2023

Question 12

List 7 factors that affect the demand for the Australian dollar.

Answer 12

Terms of trade
Demand for exports
Financial flows in
Speculation
Interest rate
Global growth
International competitiveness

Question 13

List 7 factors that affect the supply of the Australian dollar.

Answer 13

Inflation
Demand for imports
Financial flows out
Speculation
Interest rates
Domestic growth
International competitiveness

Question 14

How has the value of the Australian dollar changed over the past 20 years?

Answer 14

The TWI doubled from 2003-2013 due to the mining boom, and then depreciated by about 20% since 2013

Question 15

What is international competitiveness?

Answer 15

The cost of a country’s exports relative to those from other countries (i.e. can we produce a product more efficiently than other countries?)

Question 16

List 6 effects of a change in the exchange rate.

Answer 16

International competitiveness
Exports and imports
Foreign investment into Australia
Returns on overseas investments
Debt servicing and repayments
Valuation of foreign assets (the ‘valuation effect’)
Inflation