Table of contentsExchange rate: the rate at which a unit of domestic currency is exchanged for a given amount of foreign currency. In simple terms, people who may have demand for the Australian Dollar The Australian Dollar could include: The demand for the Australian Dollar will be affected by a number of factors. These factors are: Price expectations Demand for Australian exports. People likely to create a supply of Australian dollars are: The supply of Australian dollars will be affected by a number of factors. These factors are: The extent of financial flows out of Australia Price expectations Domestic demand for imports Reserve bank intervention in the foreign exchange market Government policies relating to the exchange rate Intervention direct The purchase of Commonwealth Government securities in its domestic operations Indirect intervention Apart from the positive effects mentioned above, there are also negative effects. They are: APPRECIATION As with depreciation, appreciation has both negative and positive effects. Some of the positive effects include: The negative effects of a currency appreciation are: What factors affect the demand and supply of Australian dollars in the foreign exchange markets? Distinguish between the causes and possible effects of currency depreciation and currency appreciation on the Australian economy. What forces, if any, came into play over the past four months and affected the value of the Australian dollar? Say no to plagiarism. Get a tailor-made essay on “Why Violent Video Games Should Not Be Banned”? Get the original essay Exchange rate: The rate at which a unit of domestic currency is exchanged for a given amount of foreign currency. BRIEF HISTORY OF THE AUSTRALIAN DOLLAR Until 1971, the Australian dollar (AUD) was pegged to the pound sterling. This meant that the AUD rose or fell in relation to the British Pound. In 1971, the AUD became pegged to the US dollar. These currencies were fixed currencies, which meant that the Australian currency would only change in value when a major global currency also changed. This system only lasted until 1974, when the AUD was pegged to a selection of other trade-weighted currencies. It was still a fixed currency. In 1976, this selection of currencies became mobile. Small changes may have been made if necessary. In 1983, the AUD became a floating currency. This means that the value of the dollar is determined by supply and demand. Initially, the Reserve Bank of Australia was not expected to intervene in the market, but since then it has been deemed necessary to intervene, usually to support prices. As in Australia, supply and demand factors largely determine the equilibrium price of the dollar. The exchange rate is sensitive to changes in supply and demand, which can lead to changes in the equilibrium exchange rate. Another factor that can affect the supply and demand of Australian dollars is market intervention by the Reserve Bank of Australia. DEMAND The demand for Australian currency in the foreign exchange (Forex) market is derived demand. It is derived from the demand for a country's exports of goods and services and its assets. Simply put, people who may have demand for the Australian dollar could include: Foreigners wishing to purchase Australian exports International tourists visiting Australia International investors wishing to purchase Australian shares or real estate Businessesinternational companies setting up branches or expanding into AustraliaSpeculators and investors who believe the value of the Australian dollar will increase in the hope of making a profit. Demand for the Australian dollar will be affected by a number of factors. These factors are: The scale of financial flows to Australia. The scale of financial flows into Australia from investors who wish to invest in Australia and the need to convert their currency into AUD will affect the demand for the dollar. The level of capital inflows will be affected by the level of Australian interest rates relative to foreign interest rates as well as the level of confidence in the Australian economy. If Australia has relatively higher interest rates and stronger confidence, this will encourage capital inflows and increase demand for the AUD. According to this theory, the Australian dollar currently appears to be in a relatively strong position. Interest rates are starting to rise (the official interest rate recently increased by 0.25 points to 4.5 percent and is expected to reach 5.25 percent by September this year, with economic growth increasing expected to be around 3.75 percent in 2002/03). confidence in future economic growth is the recent budget. The 2002/03 budget published on May 14, 2002 was a deficit budget. This means that the government spent more than it earned. This is a cash injection into the Australian economy that will boost economic activity and growth. Price Expectations Expectations of future AUD appreciation will increase demand for AUD from speculators, as they hope to profit from buying the dollar now and selling later at a higher price. Demand for Australian exports Demand for Australian exports varies for a variety of reasons. One of the reasons is the evolution of raw material prices. Another problem concerns the terms of trade. Both of these variations tend to have an immediate impact on the AUD. A rise in commodity prices and an improvement in terms of trade should generally improve the current account deficit (CAD). This will often result in an increase in the value of the AUD due to the expectation of an improvement in the CAD in the short to medium term. Demand for Australian exports is also influenced by the level of international competition and Australia's rate of inflation relative to other countries. If Australian businesses are competitive in the global market and Australia's inflation rate remains low, this means Australian exports will be cheaper for foreigners, making them more attractive to buy. Changes in global income levels will also influence overseas demand for Australian exports. Demand for Australian commodity exports, in particular, is highly dependent on the income levels of Australia's trading partners. When the global economy is in a period of recovery, demand and prices for Australian exports will increase. Overseas consumer tastes and preferences for Australian exports also affect global demand for Australian exports. An increase in demand for Australian dollars generally causes the value of the currency to appreciate. A supply and demand curve is displayed on the page, demonstrating an appreciation of the dollar. SUPPLY The supply of Australian currency is also derived. It arises from the demand of Australian residents for foreign goods, services and assets. People who could potentially create a supply of Australian dollars are: Australians who want to buy imports atthe foreigner. Australian tourists going overseas. Australian banks and companies lending or investing money overseas. Australians paying for various services from overseas such as repaying loans or paying interest on loansSpeculators and investorsThe supply of Australian dollars will be affected by a number of factors. These factors are: The extent of financial flows out of Australia The level of financial flows out of Australia will also be determined by domestic relative to overseas interest rates as well as international confidence in Australia and in other economies. If Australian interest rates are relatively lower and confidence in the Australian economy deteriorates, capital outflows will increase, thereby increasing the supply of AUD. Currently, interest rates are at low levels, but they are expected to increase in the near future as economic confidence and growth are relatively high. This means that there will beThere will be no significant increase in the supply of Australian dollars.Price Expectations Speculators and investors in the foreign exchange market who expect the value of the AUD will sell the AUD in order to minimize losses. This will increase the supply of AUD and contribute to anticipated depreciation. Domestic demand for imports Australian importers buying overseas must sell AUD in order to obtain foreign currency to pay for their imports. The level of domestic income will largely determine the demand for imports. When the domestic economy is growing, employment and incomes increase, so the demand for imports will also increase, leading to an increase in the supply of AUD. If people have more income, they may choose to purchase foreign goods considered prestigious. The national inflation rate and the competitiveness of domestic firms that compete with imports will also influence the level of demand for imports. If Australia's domestic inflation rate is higher and its businesses are relatively uncompetitive, then imports will be cheaper than Australian-made goods and demand for imports will increase. goods and services produced abroad will increase the supply of AUD in the foreign exchange market. When the supply of dollars increases, there is usually a depreciation in the value of the currency. THE ROLE OF THE GOVERNMENT IN THE EXCHANGE RATE The government can manage the Australian currency through the Reserve Bank of Australia (RBA). The RBA can intervene in the foreign exchange market and implement government policies designed to influence the value of the dollar. Reserve bank intervention in the foreign exchange market Australia's exchange rate is generally allowed to float cleanly, with market forces determining its value. However, from time to time the RBA intervenes in the foreign exchange market to influence the value of the exchange rate, thereby dirtying the float. The intervention can take place for various reasons. These are:1. If the exchange rate deviates too far from its long-term equilibrium path, it can have negative effects on economic conditions such as inflation, employment levels, and gross domestic product.2. Intervention (as a buyer or seller of currencies) can help ease sentiment in the foreign exchange market resulting from excessive speculation.3. RBA authorities can also intervene to prevent excessive depreciation (which could lead to higher input prices and inflation) or excessive appreciation (resulting in higher export prices and loss ofinternational competitiveness) and gain time to reassess economic policy. to the exchange rate There are essentially three policies that the Australian government (through the RBA) can implement to try to influence the value of the exchange rate in a floating system: The RBA can intervene directly in the market forced as a buyer or seller. of currencies. This is generally done to smooth the market to reduce what is considered excessive volatility caused by uninformed speculation. The RBA can intervene indirectly by changing the level of interest rates through its market operations. This will have the effect of changing the interest rate differential between Australia and the rest of the world. An increase in interest rates relative to overseas will encourage capital inflows and therefore increase demand for the Australian dollar. This action could also be taken to prevent further depreciation of the Australian dollar. A fall in Australian interest rates will encourage capital flight and increase the supply of Australian dollars relative to demand. This measure would prevent further appreciation of the Australian dollar. The government could use a combination of macroeconomic policies to increase or decrease Australia's rate of economic growth relative to the rest of the world. Contractionary monetary, fiscal and industrial relations policies can reduce aggregate demand, including the demand for imports, thereby increasing the value of the exchange rate. Alternatively, the use of expansionary macroeconomic policy should boost aggregate demand, including the demand for imports relative to exports, thereby increasing economic growth, but lowering the exchange rate. Direct intervention Direct intervention by the RBA in the foreign exchange market has potential. implications for domestic liquidity. RBA intervention may be sterilized to offset effects on domestic liquidity and interest rates, or not sterilized by intervention affecting domestic liquidity and interest rates. Sterilization occurs when the RBA offsets its intervention in the foreign exchange market by buying or selling an equivalent amount of government securities, leaving the RBA's monetary liabilities unchanged. Unsterilized intervention in the foreign exchange market does not involve any compensatory purchase or sale of government securities. An unsterilized sale or purchase of foreign currencies will cause the money supply to fall or increase and interest rates to rise or fall. The RBA has always carried out a sterilized intervention. There are two ways to do this: Buy Commonwealth Government securities as part of its domestic operations. Arranging a currency swap, exchanging one currency for another in the current (spot) market and agreeing to cancel the transaction at a later date at an agreed price or exchange rate (futures market)Indirect intervention Initiatives monetary policy are a more indirect means of influencing the exchange rate and are rarely used for this purpose. If the government wants to curb rapid depreciation, it could increase demand for AUD by raising interest rates. Higher interest rates will attract more foreign savings, which will need to be converted into AUD. This will increase demand for AUD and put upward pressure on the exchange rate. However, this policy will generally only be effective for a limited period of time. It is unusual for the RBA to change interest rates in response to currency movements, as the primary aim of its monetary policy decisions is to influence the domestic economy. Sometimes theExchange rate fluctuations are so significant that they can affect the stability of the economy or the level of inflation. An example of this occurred in April 2000. The RBA stated that one of the factors which prompted it to raise interest rates was the depreciation of the Australian dollar, which increased inflationary pressures and danger of low inflation. This was the first time since 1986, when the RBA openly adjusted interest rates in response to exchange rate movements. THE EFFECTS OF EXCHANGE RATE MOVEMENTS The depreciation and appreciation in the value of the Australian dollar has negative and positive effects. If a depreciation occurs, it increases the domestic price of foreign goods and reduces the external price of exports. If an appreciation occurs, it lowers the domestic price of foreign goods and increases the external price of exports. DEPRECIATION The depreciation of the Australian currency has a number of positive effects. These are: In the long term, an exchange rate depreciation improves the competitiveness of the tradable goods sector (producers that compete with exports and imports) by making Australian goods and services cheaper and therefore more competitive through in relation to the same goods and services produced. overseas. This will help increase export earnings and reduce import expenses. Overall, this will help improve the current account deficit (CAD). This theory is known as the J-curve theory. A depreciation could encourage higher levels of capital inflows into Australia, as domestic assets become cheaper relative to their foreign counterparts. This can help reduce the level of external debt and increase foreign equity investment in Australia. A depreciation can lead to a structural change in the composition of the Australian economy, for example a shift towards manufacturing and service export industries. In addition to the positive effects mentioned above, there are also negative effects. These are: A currency depreciation can increase the cost of imports and reduce the price of exports in the short term. This may result in lower export volume revenues from the sale of a given volume of exports and an increase in the cost of a given volume of imports. Declining export revenues and increasing import spending in the short term will increase the size of the CAD. A depreciation can often lead to an increase in the inflation rate. This will happen if monetary policy is unable to contain inflationary expectations. Since the 1990s, microeconomic policies have been adopted to smooth inflation and make the economy more flexible in the face of significant monetary shocks such as the Asian crisis of 1997. Examples of these policies include corporate bargaining and national competition policy. An immediate impact of a depreciation of the dollar is to increase the value of that part of the net external debt relative to which the value of the AUD has depreciated. For example, if the AUD depreciates against the AUD, the portion of foreign debt owed to the United States will increase in value. A depreciation of the Australian dollar will increase the debt service ratio. The debt service ratio corresponds to interest repayment as a percentage of exports. Higher interest payments can result in a higher net income deficit and increase the size of the Canadian dollar. A significant depreciation could lead the RBA to intervene indirectly to support the exchange rate by raising interest rates..