ECONOMICS- EXCHANGE RATE

1. Foreign exchange market- why was it established?

• established to allow trade between countries with different currencies

1. Define exchange rate

price of one countries currency in terms of another currency eg. 1USD= 1.45 AUD

1. Steps to foreign exchange market- explain

Panel A- Aus exports to US

 

1. Aus Exporter sells kangaroo toy to american importer

2. American importer sends bank transfer in USD to australian exporter

3. Aus exporter supplies USD to Bank

4. Aus exporter demands AUD back

Panel B- Aus imports from US

1. US exporter sells t shirts

2. Aus importer supplies AUD to bank

3. Aus importer demands USD back

4. Aus importer sends bank transfer in USD

 

2. Demand for AUD

   • what relationship is it?

   • what causes movements and shifts of curve?

• negative relo- as price of AUD1 in USD decreases, then Quantity of AUD demanded decreases

• movements- caused by reliance on other countries/ exchange rate

• shift- caused by no exchange rate factors

2.1 List all the non exchange rate factors

1. Relative price levels

2. Real world gdp

3. Foreign preferences for Aus G&S

4. Relative interest rates

5. Commodity prices

6. Expectation and speculation

 

2.1.1 non exchange rate factors- relative price levels

• If inflation in other countries is greater than aus, ts causing aus g&s will be cheaper= increased demand for AUD and more appealing for foreign importers = shift right

 

2.1.2 non exchange rate factors- real word gdp

• Higher economic growth in world real GDP in australias trading partners= increasing real income of foregn citizens. This increases D for Aus g&s= increase D for AUD= shift right

• Eg. Chinas econ growth= increased real income of chinese citizens= increased D for aus iron ore, beef etc-> increased D of AUD and shift right.

  

2.1.3 non exchange rate factors- foreign preferences

• If aus g&s become more popular overseas, then demand for AUD increases= shift right

• Eg. If tourism campaign for aus= increased demand for aus tourism= increased D for AUD= shift right.

  

2.1.4 non exchange rate factors- relative interest rates

• define Interest rate differential

• explain effect on D

Interest rate differential= the difference between australian interest rate and foreign interest rate

• Interest rates reflect the return on financial assets. So when australias interest rate is higher than the US then IRD increases= increased demand for Aus assets= increased demand for AUD= shift right.

  

2.1.5 non exchange rate factors-  commodity prices

• Commodity prices determined by demand in world market.

• If iron ore prices increase due to increased demand by china= increased value of exports= increased demand for AUD= shift right

  

2.1.6 non exchange rate factors-  expectations and speculations

• Foreign currency traders expect movements in currency.

• If AUD is believed to appreciate in future- they will purchase now to take advantage of lower prices = increased demand for AUD= shift right.

3. Supply of AUD

   • define

   • law

• where aus wants to sell aud to buy foreign currency to purchase g and s from overseas

• pos- as ER increased, quantity of AUD supplied increases

3.2 causes of shift/ movement in supply curve

• shift= non exchange rate factors

• movement- change in ER

3.3 List the factors that cause shift in supply cirve

1. Relative price levels

2. AUS real GDP

3. Aus preference for foreign goods and services

4. Relative interest rates

5. Expectations and speculation

 

3.3.1 Relative price levels

• If inflation is lower in other countries relative to aus, then foreign g&s will be more attractibe to aus importers= increased D for foreign g&s = increased Supply of AUD= shift right

3.3.2 Aus real gdp

• If econ growth in aus increases= increased domestic income = increased imports from overseas = increased D for imported g and s = increased S of AUD= shift right.

 

 

3.3.3 Aus preferences for foreign g and s

If foreign g and s are more attractive- if US released ad for tourism then increased D for foreign g and s= increased S of AUD= shift right

3.3.4 Relative interest rates

• If foreign IRD increases, then demand for foreign assets increases= increased S of AUD= shift right

  

3.3.5 Expectations and speculation

• By foreign investors or trackers

• If USD is likely to appreciate in future, then australians may sell more AUD to purchase USD now before becomes more expensive = Increased S of AUD = shift right.

  

 4. Floats-

• define

• 2 types

•  countries use a float/ market determined exchange rate as it is influenced by market forces of SnD.

 

4.1 Clean float

• When a currency is allowed to float free from interference of central bank (RBA)

  

4.2 Dirty/ managed floats

• When interfference of foreign exchange rate by central bank

• Act as buyer or seller, influencing exchange rate

• Eg. When RBA would buy AUD in market to prevent AUD from falling too low

  

5. EQ ER

• when does EQ occur?

• what would happen if ER was higher than EQ

• what would happen if ER was lower than EQ

• occurs when QD=QS

• QS>QD= excess supply causing price to decrease

• QS<QD= excess demand causing price to increase

6. What 2 factors cause appreciation?

1. Demand of AUD increases= shift right

2. Supply of AUD decreases= shift left

 

6.1 Demand of AUD increases= shift right is caused by…

• Increased demand for aus exports

• Increased commodity prices

• Aus IRD increases= increased foreign investment into aus

  

6.2 Supply of AUD decreases= shift left by

• Decreased D for imports

• increases in IRD= decrease in aus investment overseas

 

7. what 2 factors causes depreciation

1. decreased demand for AUD= shift left

2. increased supply for AUD = shift right

7.1 decreased demand for AUD= shift left is caused by…

• decreased demand for aus exports

• decreased commodity prices

• decreased IRD= decreased foreign invest into aus

7.2 increased supply for AUD = shift right is caused by…

• increased demand for imports

• incrrased inflation in aus

• decrease in aus IRD= decreased AUD invest into overseas

7. summary of determinant of demand and supply

   • demand is impacted via

   • supply is impacted via

Demand

• exports of g and s

• incomr from overseas

• capital inflow

Supply

• imports of g and s

• payment of income to overseas

• capital outflow

8. Effects of movements in the ER impacts…

1. macroecon

2. trade balance

3. consumers and business

8.1 Macroeconomy

• how does depreciation impact?

  1. exports

  2. tourism

  3. domestic producers

• how does appreciation impact?

• DEPRECIATION= EXPANSION IN MACROECON

1. Increases export advantages because overseas countries can purchase more at lower price, but decreases domestic imports as price decreases

2. Tourism in aus econ increases

3. Domestic producers that do not sell imported goods increase competitiveness

 

• APPRECIATION= CONTRACTION

1. Decreases exports as more expensive

2. Decreases tourism from overseas, but aus to overseas benefit

3. Domestic producers lose

 

 

8.2 trade balance

• depreciation causes-

• 1. impact on ecports

• 2. impacts of imports

• 3. what effect?

1. Increased quantity of aus exports but no impact on price= increases value

2. Decreases quantity of aus imports but increases price = increase or decrease value depending on demand

3. Causes J curve effect- where TB will decrease at first b due to increased import value but then increases due to volume = increased TB

   

8.3 CONSUMERS AND BUSINESS

what does depreciation cause

• DEPRECIATION

1. Consumers harmed as they pay more for imports or overseas travel

2. Domestic producers that sell imported goods eg. Petrol will decrease profit due to increases price of imported goods

3. Firms that export gain as overseas demand increases

4. Domestic producers that done sell imported goods gain as increased demand for dometic produced goods.

9. BOP and ER

• linked via 2 factors

1. appreciation and depreciation

2. protection of econ from external shocks

9.1 Appreciation and depreciation

• what causes appreciation

• what causes depreciation

• Appreciation occurs when-> increased trade balance or increase in capital inflow= demand for AUD increases

• Depreciation occurs when-> increased imports or increased capital outflow = increased supply of AUD

  

 

9.2 protection from external shocks

• explain using examples of positive shock and negative shock

• Eg. Positive shock- when china econ growth= increased D for aus g and s/ exports= increased global price= increasd AUS XPI and gdp but can cause inflation. Stronger AUD slowed down the econ and decreased effects of inflation

• Eg. Negative shock- global financial crisis= aud depreciated but increased exports and expantion of aus econ= ER prevented recession because depreciated AUD= decreased price of aus g and s and increased competition

 

 

10 Recent trends in AUD ER via TWI

• define TWI

• TWI- weighted average of a basket of currencies that reflect importance of aus trade by country

• Most important - chinese yuan, jap yen, euro and USD

 

10.1 why is AUD 2x as volatile against USD in TWI?

• Single currency always flunctuates more than average ER

• USD AND TWI ARE DIRECTLY CORRELATED AS USD IS KNOWN AS GLOBAL PRICE AND IS BIGGEST ECON

  

11. Key drivers of AUD

    • list 2 factors

1. commodity prices

2. IRD

11.1 Commodity prices

• why is aus aka commodity currency?

• what do changes in commod prices influence

• relationship between the 2

• Aus = commodity currency bc over 70% of aus exports are primary commdityes

• Changes in com prices infleunce aus gdp and income

• AUD and commodity prices are positive relo as increased com prices = appreciation in AUD

  

11.2 IRD

• how is it measured

• if AUS IRD with US decreases then…

• vise versa

• why?

• Measured via difference in 3 year bond rates between 2 countries

• If AUS IRD with US decreased then AUD depreciates because IRD affects the flow of foreign investment between 2 countries

• Investors seek to receive highest returns for their funds- so less FI will flow into aus, decreasing demand for aud and increase supply of AUD as aus investors shift funds into US

 

• If aus IRD increases, then AUD would appreciate as increased D for AUD and decrease supply of AUD