EXCHANGE RATES

The Exchange Rate Exchange Rate: the value of one nation’s currency in relation to another is determined by the market forces of supply and demand for the currency. Individual Exchange Rate Each country has a daily exchange rate with another country. E.g Australia v US

Exchange Rates Trade Weighted Index Exchange Rate the average value of the $A in terms of a basket of foreign currencies of 24 of Australia’s trading partners, weighted according to their relative trading importance with Australia.

Exchange Rates Exchange rates change on the basis of supply and demand for a country’s currency on the foreign exchange market. Value goes down - Depreciation Value goes up – Appreciation

Depreciation in the AUD Depreciation in the exchange rate: an decrease in the value of Australia’s currency in relation to another country’s currency. A depreciation in the AUD can be caused by either: ◦ A decrease in demand for AUD ◦ An increase in supply of AUD

Appreciation in the AUD Appreciation in the exchange rate: an increase in the value of Australia’s currency in relation to another country’s currency. An appreciation in the AUD can be caused by either: ◦ An increase in demand for AUD ◦ A decrease in supply of AUD

Appreciation - Increase in Demand for AUD Increase in demand for AUD can be due to: strong overseas economic growth that increases the volume of our exports Australian export firms internationally competitive. Lower inflation rate in Australia compared to overseas countries making our exports more competitive. rises in commodity prices Rises in domestic interest rate encourages overseas people to put money in our banks speculation that $AUD will rise

Appreciation - Decrease in supply of AUD Decrease in the supply of AUD can be due to: Decreased spending on imports by Australians due to low consumer confidence or recession

Depreciation - Decrease in Demand for AUD Decrease in demand for AUD can be due to: Falls in commodity prices Weak overseas economic growth that decreases the volume of our exports Falls in domestic interest rate discourages overseas people to put money in our banks Speculation that $AUD will fall Higher inflation rate in Australia compared to overseas countries making our exports less competitive.

Depreciation Increase in supply of AUD Increase in the supply of AUD can be due to: Increased spending on imports by Australians due to high consumer confidence or booming economic growth

Effects of an Appreciation An appreciation in the Australian dollar results in the following: ◦ Imports become relatively cheaper for Australians to buy ◦ Exports become more expensive for overseas buyers As a result of an appreciation the following tend to occur: ◦ Increased spending on imports (↑M → ↓AD) ◦ Decreased demand and spending on Australia’s exports (↓ X → ↓AD) Therefore, an appreciation can actually lead to lower levels of production and economic growth and lower employment levels.

Winners and Losers of Appreciation Winners ◦ Australians travelling overseas ◦ Australian businesses that used imports as components in the production process. Cheaper imports decrease the cost of production. ◦ Petrol prices will tend to be lower Losers ◦ Manufacturing and agricultural exporters cannot compete locally and overseas ◦ Australian tourism industry finds it harder to attract overseas tourists plus more Australians travelilng o/s instead of locally