HSC ECONOMICS – AUSTRALIA’S PLACE IN THE GLOBAL ECONOMY – EXCHANGE RATES
AUSTRALIA’S FLOATING
EXCHANGE RATE SYSTEM
Presented by Eva Spalj
Syllabus dot point:
Exchange rates
• factors affecting the demand for and supply of Australian dollars
© Eva Spalj & Edrolo 2020
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What’s in this lesson?
What factors influence demand for the AUD?
What factors influence supply of the AUD?
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Floating
Exchange Rate
Where the value of
the exchange rate is
determined by the
forces of demand and
supply.
Indirect Method
of Quotation
Refers to the rate of
exchange between
one unit of domestic
currency and the
equivalent amount of
foreign currency.
The Market for Australian Dollars
Theory summary
Where demand and
supply intersect, we have
our equilibrium price for
AUD. This is called the
exchange rate.
Price of
AUD$ in
terms of
USD$
When discussing the
price of currency it must
always be in terms of
another currency (such
as the US dollar).
Supply
of AUD$
0.68
Note:
The quantity of AUD
traded is found on
the horizontal axis.
Demand
for AUD$
Q
© Eva Spalj & Edrolo 2020
Quantity
of AUD$
3
Floating
exchange rate
Where the value of
the exchange rate is
determined by the
forces of demand
and supply.
Appreciation
An increase in the
value of a currency
in a floating
exchange
rate system.
The Market for Australian Dollars
Supply
of AUD$
Appreciation
© Eva Spalj & Edrolo 2020
The A$ is demanded
in the foreign
exchange market to:
• Buy exports of
goods and
services
• Send income into
Australia
• Invest in Australia,
capital inflow
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Appreciation
An increase in the
value of a currency
in a floating
exchange rate
system.
What factors influence the demand for the AUD?
The demand for Australian exports by foreigners:
Supply of
AUD$
Increased demand
for Australian X à
increase in demand
for AUD (shift to the
right) à appreciation
of the AUD.
Decreased demand
for Australian X à
decrease in demand
for AUD (shift
to the left) à
depreciation of
the AUD.
Appreciation
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Terms of Trade
The ratio of export
prices to import prices.
What factors influence the demand for the AUD?
Relative rates of domestic and world economic growth:
Relatively strong
world growth
Increased demand for
AUS exports
Increased demand
for AUD
Terms of trade movements:
Higher
commodity
prices
Favorable
terms of
trade
Higher
export
income
Increased
demand
for AUD
The demand for Australian assets such as shares, real estate, government bonds, and currency:
Increased
demand for
AUS assets
Capital inflow
into AUS
Foreigners convert
their currency
© Eva Spalj & Edrolo 2020
Increased
demand for AUD
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Interest rates
Annual percentage
cost of borrowing
funds or percentage
return on a financial
asset.
Inflation rate
The rate at which
prices increase over
time, resulting in a
fall in the purchasing
value of money.
What factors influence the demand for the AUD?
Australia’s relative interest rate (differential):
Rise in relative
interest rate
differential
Greater
returns on
investment
Attracts
Increased demand
more FDI
for AUD
Australia relative inflation rate (differential):
Rise in relative
inflation rate
differential
Increased
prices
Decreased
international
competitiveness
for exports
Decreased
demand
for exports
Exchange rate expectations:
Expectation
of future
appreciation
Expectation
of future gain
and profit
© Eva Spalj & Edrolo 2020
Increased
demand
for AUD
Decreased
demand
for AUD
International
Competitiveness
Refers to a country’s ability to
compete with other countries on
international markets. It takes
into account both price and
non-price factors.
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Depreciation
A fall in the value
of a currency in a
floating exchange
rate system.
What factors influence the supply of the AUD?
The demand for foreign imports by Australians:
Supply
of AUD$
Price of
AUD$ in
terms of
USD$
S2AUD$
Increased demand
for foreign M à
increase in supply
of AUD (shift to the
right) à depreciation
of the AUD.
Decreased demand
for foreign M à
decrease in supply
of AUD (shift to the
left) à appreciation
of the AUD.
0.68
Depreciation
0.64
Demand
for AUD$
Q
Q2
© Eva Spalj & Edrolo 2020
Quantity
of AUD$
8
Interest rates
Annual percentage
cost of borrowing
funds or percentage
return on a financial
asset.
What factors influence the supply of the AUD?
The demand for foreign assets such as shares, real estate, government bonds, and currency:
Increased
demand for
foreign assets
Capital outflow
from AUD
Australians convert
their currency
Increased supply
of AUD
Australia’s relative interest rate (differential):
Fall in relative
interest rate
differential
Lower returns
on investment
Increased
demand for
foreign assets
© Eva Spalj & Edrolo 2020
Outflow of capital
Increased supply
from AUS
of AUD
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What factors influence the supply of the AUD?
Exchange rate expectations:
Expectation
of future
depreciation
Expectation
of future loss
Increased
supply of AUD
Relative rates of domestic and world economic growth:
Higher AUS growth
Increased demand
for imports
© Eva Spalj & Edrolo 2020
Increased supply
of AUD
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Balance of
Payments
The balance of
payments (BoP)
is a record of all
transactions between
residents of a country
and the rest of the
world over a given
period.
Link to the Balance of Payments
Changes in the demand and supply of Australian dollars are influenced by transactions in the
current account, and capital and financial accounts of the Balance of Payments.
Factors affecting Demand and supply of AUD
Balance of Payments
Demand for AUS
exports (X)
Demand for AUD
Credit on the BOGS –
Current Account
Demand for foreign
imports (M)
Supply of AUD
Debit on the BOGS –
Current Account
Demand for
Australian assets
Demand for AUD
Credit on the Financial
Account
Demand for foreign
assets
Supply of AUD
Debit on the Financial
Account
© Eva Spalj & Edrolo 2020
Influences
• Interest rate differential
• Terms of trade
• Domestic and world
economic growth rates
• Interest rate differentials
• Exchange rate expectations
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Multiple choice activity
Which of the following are the most likely effects of an increase in Australian interest rates
relative to overseas interest rates?
A. Decreased outflow of capital and an depreciation of the Australian dollar.
B. Increased outflow of capital and a depreciation of the Australian dollar.
C. Decreased inflow of capital and an appreciation of the Australian dollar.
D. Increased inflow of capital and an appreciation of the Australian dollar.
E. I don’t know.
© Eva Spalj & Edrolo 2020
(Written by the author)
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Multiple choice – Response
Which of the following are the most likely effects of an increase in Australian interest rates
relative to overseas interest rates?
A. Decreased outflow of capital and an depreciation of the Australian dollar.
B. Increased outflow of capital and a depreciation of the Australian dollar.
C. Decreased inflow of capital and an appreciation of the Australian dollar.
D. Increased inflow of capital and an appreciation of the Australian dollar.
E. I don’t know.
© Eva Spalj & Edrolo 2020
(Written by the author)
13
Multiple choice activity
Which of the following would NOT account for the change shown in the diagram?
A. Increased Australian economic growth
B. More capital outflows
C. Decreased imports
D. Increased speculation
E. I don’t know.
Diagram from 2Z019 HSC Exam
© Eva Spalj & Edrolo 2020
(Written by the author)
14
Multiple choice – Response
Which of the following would NOT account for the change shown in the diagram?
A. Increased Australian economic growth
B. More capital outflows
C. Decreased imports
D. Increased speculation
E. I don’t know.
Diagram from 2Z019 HSC Exam
© Eva Spalj & Edrolo 2020
(Written by the author)
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© Eva Spalj & Edrolo 2020
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