Topic 2: Exchange Rates
Top Economics
Facts
Fixed to Floating
• 1983 Australia switches to a
floating exchange rate. Value of
AUD now determined by market
forces rather than by the
government. This opens the Aus
economy up to global financial
flows.
• Value of currencies under a
floating exchange rate are
determined by market forces, i.e
supply and demand.
What does it all mean?
• On a basic level exchanges impact the price of goods and services between
countries.
• If the AUD appreciates: Our exports become more expensive and our
imports become cheaper. You can now buy those shoes from the US online
for less Australian dollars. They cost the same amount of US dollars, lets
say $50USD but your Australian dollars are worth more so its “cheaper” for
you here in Aus.
• If the AUD depreciates: Our exports become cheaper and our imports
become more expensive. Now it’s going to cost you more to buy those
shoes from the US. Again, they’re still $50USD but your Australian dollars
aren’t worth as much, so you need more of them to pay for the shoes and
therefore “more expensive” for you here in Aus.
Changes in
Demand for
AUD
• Size of financial flows
- Level of our interest rates. Investors will seek higher interest for
their money. As they invest in that country they will need that
country’s currency and therefore are ‘demanding’ it.
• Speculation – Speculators cause the speculation that they
speculate
• Demand for our exports
- Changes in commodity prices and therefore our terms of trade
- Our international competitiveness/keeping inflation low. Both
of these keep our prices low and allow trade partners to demand
our exports and therefore demand our currency as they pay us in
AUD.
- Global economic conditions: Our trade partners need to be
growing and performing well to continue demanding our
particular exports. If China and South East Asia are not
experiencing strong economic growth then neither will our
exports be in as high a demand.
- Taste and preferences of our products: This can include tourism,
if people want to travel to Australia then they have to convert
their currency to AUD i.e they demand our AUD.
Changes in
Supply of
AUD
• Investment flows out of Australia:
- Global interest rates compared to Australia.
If there are higher interest rates overseas
then Australians will send their money
overseas and supply our AUD causing the
dollar to depreciate
• Speculation
• Domestic demand for imports
- When we buy products from overseas we
are essentially supplying our AUD to them.
When AUD are used overseas they are
exchanged into that country’s currency. This
leads to a depreciation of our currency
HSC short answers
Appreciations | Depreciations
The floating exchange rate as an automatic stabiliser
Causes/Reasons
(this is a big slide, these are good extended
response, paragraph points to use)
The TRADE WEIGHTED INDEX (TWI)
• Comparing the AUD to a single other currency such as the USD can be
misleading. The USD is the most commonly traded currency globally so it
makes sense to compare to this but what if we appreciate against the USD
but depreciate against several other countries? Is it really fair to say the
AUD has appreciated if its only against the USD?
• The TWI is a more accurate measure of the performance of the AUD.
• Weights for the TWI – 2022 | RBA
• The RBA changes the weighting of currencies within the TWI based on the
volume of trade we do with that country in the previous year.
The currencies in our TWI must make up at least 90% of all our trade
• TREND: In recent decades one trend has been the Japanese YEN and the
USD have fallen in weighting and the Chinese RENMINBI has risen in
weighting (due to increased trade with China and decreased trade with
Japan and the US).
HSC short answers
Effects