Exchange Rates The value of one country s

Exchange Rates • The value of one country’s currency in terms of another country’s currency. • 1983 Australia changed to a flexible exchange rate (floating exchange rate) • Forces of demand supply on FOREX (foreign exchange) markets determine the exchange rate.

Trade weighted Index • Measures movements in the exchange rate compared to major trading partners • Over the last 5 years the AUD has been appreciating relative to the US$ + TWI • Graph the AUD relative to the US$ and TWI over the last 8 years – page 135 • what is the AUD exchange rate today?

Depreciation • decrease in value of currency • $1 AUD= $1 US • $1 AUD=$0. 90 US • Why does a depreciation occur? • Use demand supply diagrams

Depreciation – positive effects • Increase international competitiveness – export prices can fall and import prices can rise. The impact of this will depend on the price elasticity of demand for exports and imports. WHY? • CAD should improve if X growth increases. • Encourage foreign investment • Increased economic growth rates.

Depreciation – negative effects • Increases interest servicing costs for funds borrowed from overseas- valuation effect - increases CAD • Increases the Foreign debt in AUD for those that have borrowed from overseas – valuation effect • Increased domestic inflation as import prices increase. • A large and sudden depreciation may prompt RBA intervention. NOTE: an appreciation has the opposite positive and negative effects

Appreciation • What is an appreciation? • Why do currencies appreciate? • What are the positive effects? • What are the negative effects?

Summary • Overall a depreciation is generally considered good by exporters because it increases international competitiveness and bad by those that have borrowed from overseas or are travelling overseas.

Role of RBA • RBA intervenes in FOREX markets from time to stabilise the currency- this is called dirtying the float. • Direct RBA intervention can only be a short-term • RBA intervention can also be indirect via domestic interest rates

Fixed or Managed exchange rates • Some countries attempt to manage their exchange rates. Singapore and China • The central bank buys or sells currency to maintain stability in the market • Managed currencies tend to discourage currency speculators

Revision • Complete the multiple choice and short answer question. • Complete questions 1 -10 from text page 143 • Discuss the effects of an appreciation of the Australian dollar on Australia’s internal and external stability.