Exchange Rates

Question 1

What is an exchange rate?

Answer 1

The price of one country’s currency in terms of another country’s currency.

All countries do not have the same currency therefore a rate of exchange has to be established in order for trade to take place.

Question 2

AUD to USD..

Answer 2

AUD 1 = USD 0.75 = to get USD 1 divide AUD by USD.

USD 1 = AUD 1.33.

Question 3

Foreign exchange rate?

Answer 3

Market in which the currencies of different countries are bought and sold.

Question 4

Increase in supply, increase in demand.

Answer 4

Supply = shifts to the right.
Demand = shifts to the right.

Question 5

If we are importing more e.g US..

Answer 5

Increase in imports
Increase in supply of AUD to the US
Which results in a decrease in value of the Australian dollar

Question 6

Two methods of determining the price of a country’s currency

Answer 6

Allowing the market forces of supply and demand to freely set the value
OR
Artificially setting the price at a fixed rate
(Fixed and floating exchange rates)

Question 7

Fixed ER

Answer 7

Value of the currency is maintained at the same rate for long periods of time
The government manipulates the value of a country’s currency

Question 8

Floating ER

Answer 8

A changing value (determined by the market forces of supply and demand)
Value can change daily, or even by the second

Question 9

Advantages of floating

Answer 9

Help to insulate the domestic economy from external shocks (GFC)
Not being controlled by the government -> being controlled by S and D
Advantage of providing an automatic adjustment in the BOP

Question 10

Disadvantages of floating

Answer 10

Increase uncertainty for buyers and sellers

Uncertainty effectively increases the cost of international transactions

Question 11

Factors affecting demand for a currency

Answer 11

Exports of goods and services
Receipts of income from overseas
Capital inflow (foreign investment)

Question 12

Factors affecting supply for a currency

Answer 12

Imports of goods and services
Payment of income overseas
Capital outflow (investment abroad)

Question 13

If demand for AUD increases (floating)

Answer 13

Appreciation in the dollar
Demand curve shifts to the right

Occurs if there’s an increase in
Increase demand for Aus exports
Increase in foreign investment into Australia
Increase in income receipts from overseas residents

Question 14

If supply of AUD increases (floating)

Answer 14

Depreciation in the dollar
Supply curve shifts to the right

Occurs if..
Increase in spending on imports
Increase in foreign investment to foreign countries
Increase in income payments to overseas residents

Question 15

Clean float

Answer 15

No interference from central banks (how much supply and demand of the currency).

Question 16

Dirty float

Answer 16

Interference from central banks (to influence the movement of the currency, or to its set value in a particular range)

Question 17

Monetary policy

Answer 17

Used to set short term interest rates

Question 18

BOP and the exchange rates

Answer 18

A free exchange rate has the advantage of providing an automatic adjustment in the BOP

An increase in the CAD, will lead to an exchange rate depreciation (vice versa)

If the price of imports increases, it could lead to an increase in the total imports if demand is inelastic (increases demand for USD dollars, increases the supply of AUD)

Depreciation can lead to an increase in trade deficit (known as the J-curve effect)

Question 19

Factors of a decreased (depreciation) exchange

Answer 19

More competitive
Increase in exports, decrease in imports
Reduces trade deficit
Decrease interest rates

Question 20

Factors of an increased (appreciation) exchange rate

Answer 20

Less competitive
Decrease in exports, increase in imports
Increase trade deficit
Increase interest rates

Question 21

Negative external shock (advantage of free exchange)

Answer 21

Asian financial crisis -> decrease in exports from Asia -> Australia was more competitive -> protected Australia from crisis.

Question 22

Positive external shock (advantage of free exchange rate)

Answer 22

Economic growth in China -> increased commodity prices -> increase in AUD exchange rate -> increase export prices -> protected inflation from increasing.

Question 23

Recent trends in the E.R

Answer 23

Increase in the Australian dollar (2006-08)

GFC however, caused this increase to crash

Began to increase linearly again in 2011
(Strong appreciation in the Australian dollar)
July 2011, it reached 1.10 (highest value since 1983)
Australia’s terms of trade was at it’s peak
(Mining boom peak)

Mining boom ended 2012 - decrease price of coal and iron ore (primary commodities)

Depreciated to 0.70c in 2015