Exchange Rates

• Exchange rates


  The price of one country's currency in terms of another
• Trade Weighted Index (TWI)


  An indication of how the value of the Australian dollar is moving against all currencies in general
• Interest rates


  The cost of borrowing or the return on investment
• Appreciation


  An increase in the value of the Australian dollar relative to other currencies
• Depreciation

  A decrease in the value of the Australian dollar relative to other currencies
• Fixed exchange rate


  When the government or central bank officially sets the exchange rate
• Flexible exchange rate


  A system in which the exchange rate is determined by supply and demand with no central bank intervention
• Dirty float


  A managed flexible exchange rate system with some central bank intervention to modify highs and lows of the currency
• Direct intervention


  When the Reserve Bank of Australia intervenes as a buyer or seller to stabilize the Australian dollar
• Indirect intervention


  When the Reserve Bank of Australia uses monetary policy decisions to influence the exchange rate
• Protection


  Any type of government action that has the effect of giving domestic producers an artificial advantage over foreign competitors
• Free trade agreement

  An agreement between countries to reduce or eliminate trade barriers and facilitate the movement of goods and services
• Retaliatory effects

  Responses from international economies to protectionist policies, often resulting in trade conflicts or wars
• Exchange rate


  The price of one country's currency in terms of another
• Forex market


  Where currency conversion occurs through supply and demand forces or government intervention
• Australian dollar (AUD)


  The currency of Australia, ranking as the world's sixth-most traded currency
• Floating exchange rate


  E/R determined by free market forces of supply and demand
• Fixed exchange rate

  E/R set by government or central bank, not influenced by market forces
• Flexible peg


  A system where the E/R is periodically adjusted within a range
• Currency union


  An agreement between countries to use a common currency, such as the Eurozone
• Trade Weighted Index (TWI)


  Indication of the A$ value against major trading partners' currencies
• Appreciation


  Increase in the E/R of one currency in terms of another
• Depreciation


  Decrease in the E/R of one currency in terms of another
• Reserve Bank of Australia (RBA)


  Australia's central bank, responsible for monetary policy and currency stability
• Speculation


  Purchasing or selling currency in anticipation of E/R changes, leading to increased volatility
• Quality of life

  Australia ranked fifth in the world according to the UN's 2021-22 Human Development Index
• Economic development

  Australia has a very high level of economic development
• Exchange Rate

  The price of one countries currency in terms of another
• Exchange rate movements have a significant impact on international competitiveness, trade flows, investment decisions, inflation and many other factors in the economy as all trade and financial relationships between countries are mediated through the exchange of currencies
• Financial flows in affecting the demand and supply of AUD

  • Level of Australian interest rates relative to overseas interest rates
  • High domestic rates attract foreign investment and by contrast low domestic rates incentivise saving funds in overseas banks
  • Investment opportunities
  • High opportunity domestically support a high demand for AUD
  • Speculation
  • If there is an expectation of a future appreciation there may be a high demand for AUD
• Trade Flows in affecting the demand and supply of Australian dollars

  • Exports
  • If there is a high demand for domestic exports (due to high competitiveness or low inflation causing comparative advantage) there will be a high demand for AUD
  • Imports
  • If there is a high demand for imports (due to low competitiveness and high inflation making it expensive to purchase domestically) there will be a high supply of AUD
  • Commodity prices and terms of trade
  • Improvement in commodity prices and TOT increases the value of exports causing high supply of AUD
• Economic conditions in affecting the demand and supply of Australian dollars

  • Expansionary periods
  • An upturn in the domestic and/or international business cycle may increase demand for Australia's exports creating a high demand for AUD
  • Contractionary periods
  • A downturn in the domestic and/or international business cycle may decrease demand for Australia's exports creating high supply of AUD
• Trade Weighted Index (TWI)


  Gives an indication of how the value of A$ is moving against all currencies in general

  • Calculated by measuring the value of the A$ against all of the currencies of Australia's major trading partners compared with a base year
• Limitation of the TWI

  TWI is weighted based on volume of trade regardless of the currency in which exports and imports are invoiced. Australia often sells its commodities in USD even when trading with another country.
• A floating exchange rate can also act as a "automatic stabiliser" to help protect the economy from external booms and busts (business cycle fluctuations)
• Appreciation

  • An increase in Australian interest rates OR decrease in overseas interest rates
  • Improved investment opportunities in Australia OR deterioration in foreign investment opportunities
  • A rise in commodity prices and an improvement in Australia's TOT
  • An improvement in Australia's international competitiveness
  • Lower inflation in Australia
  • Increase demand for Australia's exported goods and services
  • Expectations of a current appreciation based on forecasts on one the above factors
• Depreciation

  • A decrease in Australia's interest rates OR increase in overseas interest rates
  • Deterioration in investment opportunities in Australia OR improvement in foreign investment opportunities
  • A fall in commodity prices and a deterioration in Australia's TOT
  • Higher inflation in Australia
  • Increased demand for imported goods and services
  • Expectations of a current depreciation based on forecasts of one of the above factors
• Fixed Exchange Rate

  Government or RBA officially sets E/R
• Managed Peg Exchange Rate


  Refers to any official intervention by a government in setting the E/R
• Direct intervention / Dirtying the float

  • RBA intervenes as either a buyer or seller to stabilise A$
  • To curb a rapid depreciation the RBA buys A$ putting upward pressure in the E/R (higher demand for A$ leads to an appreciation)
  • By selling A$ RBA may prevent rapid appreciation (increased supply depreciates A$)
  • RBA ability to intervene is limited by its relatively small foreign current holdings