Economic Goal 4:
External Stability
Exchange Rate
The Exchange Rate

Individual 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.
The Exchange Rate

Trade Weighted Index: the average value
of the Australian dollar against a basket of
foreign currencies of Australia’s trading
partners, weighted according to their relative
trading importance with Australia.

The statistic we use to measure the general
trend in the exchange rate is the Trade
Weighted Index (TWI)
Trade Weighted Index

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The Trade Weighted Index represents a measure
of the value of the Australian $ against a basket
of currencies comprising the currencies of our
major trading partners.
An improvement (increase) in this index means
the value of the Australian dollar is increasing
compared to the value of these currencies.
The improvement in the TWI will see the price
of our exports to become relatively more
expensive to and the price of imports become
relatively cheaper to purchase.
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
Increased Commodity Prices
Strong growth in China
Improved terms of Trade
Terms of Trade
Terms of Trade is a ratio of export prices
to import prices. It is a measure that
reflects changes in the average prices
received for a basket of exports against
those average prices paid for a basket of
import.
 The index shows changes in the actual
quantity of imports that may be purchased
with a given quantity of exports.

Appreciation of AUD
Increase in demand for AUD can be due to:
 rises in commodity prices
 strong overseas economic growth
 Favourable movement in the Terms of Trade
 Rise in domestic Interest rate (difference in
relative interest rates)
 Speculation
Depreciation of AUD
Decrease in supply of the AUD can be due to:
 A fall in economic activity overseas,
 Falling commodity prices
 Recession in Australia – reduced imports
 Falling interest rates
Consequences of a Higher Exchange Rate
Impact on the Balance on Good and
Services (Net Goods and Services) on
Current Account
 The increase in the value of the Australian
dollar makes our exports relatively more
expensive for foreigners to purchase. This
makes it harder for Australia’s tradeable
exporters (manufacturing, tourism and
education) to compete.
 This may lead to a decrease demand for
Australia’s exports and result in lower export
values.
1.
Consequences of a Higher Exchange Rate
In addition, imports become relatively
cheaper for Australians to purchase which
may increase the demand for imports.
 Overall, export values should decrease
leading a decrease in goods and services
credits and import values should increase
leading to an increase in goods and services
debits.
 This may contribute to a worsening in the
Balance of Goods and Services and a
worsening of the Current Account Deficit
in the Balance of Payments

Consequences of a Higher Exchange Rate
1.
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Impact on Net Income component on
Current Account
An increase in the value of the Australian dollar
means our currency buys more of another
nation’s currency.
If our foreign debt is valued in $US or another
currency then our interest repayments on the
debt are lower as we need to use less Australian
dollars to pay back the interest in $US.
This would reduce the value of debits in the Net
income component of the Current Account
This would result in a reduction in the size of
the net income deficit of the current account.