exchange rates

Question 1

defintion

Answer 1

the price of one country’s currency in terms of another

Question 2

what is the foreign exchange market?

Answer 2

currencies are bought and sold on the foreign exchange market
currencies that are traded on the foreign exchange market can be thought of as goods with the price determines by supply and demand

Question 3

what are the methods to determine the exchange rate?

Answer 3

fixed
floating
managed

Question 4

what is a fixed determination?

Answer 4

the government artificially sets the fixed rate
less volatility and greater certainty with a fixed exchanged rate as the value of currency is maintained at the same rate for long periods

Question 5

what is a floating currency?

Answer 5

market forces (supply and demand) determine the value of currency 
helps to cushion the economy when there is a shock - in a global downturn the the AUD automatically adjusts by depreciating which supports the AE  
disadvantage - high degree of uncertainty and currency speculation that takes place

Question 6

what is a managed currency?

Answer 6

demand and supply determine the exchange rate however the RBA sometimes intervenes if they believe that the currency is undervalued or overvalued and they believe this threatens our economic welfare

Question 7

what is the relationship between the balance of payments and a freely floating exchange rate?

Answer 7

a floating exchange rate means that the total balance of payments will always balance
credits (demand for AUD) = debits (supply for AUD)
a deficit in the current account results in an equal surplus in the capital financial account as the balance of payments always equals 0

Question 8

what are the factors that affect the exchange rate?

Answer 8

commodity prices
relative inflation
TOT movements
domestic econ growth
relative interest rates
other factors

Question 9

how do commodity prices effect the ER?

Answer 9

australia has a commodity currency - around 65% of Australia’s exports are made up of primary commodities
there is very strong positive correlation between movements in commodity prices and the AUD

Question 10

how does relative inflation effect the ER?

Answer 10

if Australia’s inflation rates rise relative to other countries our exported goods will will be relatively more expensive
decreasing exports as Australian exporters are less internationally competitiveness
decreases the demand for the Australian dollar, depreciating the AUD

Question 11

how do TOT movements effect the ER?

Answer 11

favourable movement in the terms of trade leads to an appreciation
unfavourable movement in the terms of trade leads to a depreciation

Question 12

how does domestic economic growth effect the ER?

Answer 12

increasing economic growth leads to a depreciation (high supply)
decreasing economic growth leads to an appreciation (low supply)

Question 13

how does world economic growth effect the ER?

Answer 13

increase in world economic growth leads to a appreciation (high demand)
decrease in world economic growth leads to depreciation (low demand)

Question 14

how do relative inflation rates effect the ER?

Answer 14

higher interest rates leads to an appreciation

lower interest rates leads to a depreciation

Question 15

what are the effects of a depreciation on exports?

Answer 15

exports become cheaper for foreign residents
the prices of Australian goods and services in foreign currency will fall
foreign residents will give up less of their currency to purchase Australian goods
rise in demand for Australian exports ceteris paribus

Question 16

what are the effects of a depreciation on imports?

Answer 16

imports become more expensive for domestic residents
give up more currency to purchase foreign goods and services
decrease in demand for imports

Question 17

what are the effects of a depreciation on the goods and services in the currenct account?

Answer 17

rise in the trade balance - increase demand for exports (increase in export price index) and decrease demand for imports (decrease in import price index)
smaller trade deficit or higher trade surplus
smaller current account deficit ceteris paribus

Question 18

what are the effects of a depreciation on employment?

Answer 18

higher demand for our exports - increase in output in the economy particularly in the traded goods sector
increased demand for Australian exports results in higher output and employment

Question 19

what are the effects of a depreciation on import replacement industries?

Answer 19

benefit import replacement industries as import prices become more expensive
Australian consumers will therefore choose to purchase goods from import replacement industries as they are relatively cheaper

Question 20

what are the effects of a depreciation on inflation?

Answer 20

will lead to a rise in inflation rates ceteris paribus as imports become more expensive
higher prices for consumers and higher production costs for firms who rely on foreign input
increase in the price of imports will lead to a rise in the general level of prices in the economy

Question 21

what are the effects of an appreciation on exports?

Answer 21

exports become more expensive for foreign residents
the prices of Australian goods and services in foreign currency will rise
foreign residents will give up more of their currency to purchase Australian goods
fall in demand for Australian exports ceteris paribus

Question 22

what are the effects of an appreciation on imports?

Answer 22

imports become less expensive for domestic residents
give up less currency to purchase foreign goods and services
increase in demand for imports

Question 23

what are the effects of an appreciation on the goods and services component of the current account?

Answer 23

fall in the trade balance - decrease demand for exports (decrease in export price index) and increase demand for exports (increase in import price index)
larger trade deficit or lower trade surplus
larger current account deficit ceteris paribus

Question 24

what are the effects of an appreciation on employment?

Answer 24

lower demand for our exports - decrease in output in the economy particularly in the traded goods sector
decrease demand for Australian exports results in lower output and employment

Question 25

what are the effects of an appreciation on import replacement industries?

Answer 25

disadvantage import replacement industries as import prices become less expensive
Australian consumers will therefore choose not to purchase goods from import replacement industries as they are relatively more expensive

Question 26

what are the effects of an appreciation on inflation?

Answer 26

will lead to a fall in inflation rates ceteris paribus as imports become less expensive
lower prices for consumers and lower production costs for firms who rely on foreign input
decrease in the price of imports will lead to a fall in the general level of prices in the economy

Question 27

what happened to the ER in late 2008 - late 2009?

Answer 27

rapid decline in the value of the $A against the TWI and $US
was US97c in mid 2008 and fell to just over US60c in March 2009
due to weaker global economic growth, rapidly falling commodity prices, lower domestic interest and fears of an economic meltdown

Question 28

what happened to the ER in late 2009 - 2012

Answer 28

reached parity with USD in 2010
interest rates remain low
in late 2011, the AUD peaked at USD1.10 due to strong commodity prices and a large interest rate differential
cash rate was 4.75

Question 29

what happened to the ER in 2017?

Answer 29

currently the AUD is around USD75c
significant depreciation in the AUD compared to the USD in less than six years
caused by a fall in commodity prices, smaller interest rate differential, weakness in the chinese economy