IndexExchange rate: the rate at which a unit of domestic currency is exchanged for a given amount of foreign currencyIn simple terms, people who may have a demand for the The Australian dollar could include: Demand for the Australian dollar will be affected by a number of factors. These factors are: Price expectations Demand for Australian exports People who could create a supply of Australian dollars are: The supply of Australian dollars will be influenced by a number of factors. These factors are: The magnitude of financial flows out of Australia Price expectations Domestic demand for imports Reserve Bank intervention in the Forex market Government exchange rate policies Direct intervention Purchase of Commonwealth government bonds in its national operations Indirect intervention Along with the positive effects mentioned above, there are also negative effects. These are: APPRECIATION As with depreciation, appreciation has both negative and positive effects. Some of the positive effects include: The negative effects of a currency appreciation are as follows: What factors influence the supply and demand for Australian dollars in the foreign exchange markets? Distinguish between the possible causes and effects of currency depreciation and appreciation on the Australian economy. What forces have come into play, if any, over the last four months that have affected the value of the Australian dollar? Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get an original essayExchange Rate: The rate at which a unit of domestic currency is exchanged for a given amount of foreign currency A BRIEF HISTORY OF THE AUSTRALIAN DOLLARUntil 1971, the Australian dollar (AUD) was pegged to the British pound. This meant that the AUD rose or fell in line with the pound. In 1971, the AUD was pegged to the US dollar instead. These currencies were fixed currencies, which meant that the Australian currency only changed value when one of the major world currencies also changed. This system lasted only until 1974, when the AUD was pegged to a weighted selection of other currencies. This was still a fixed currency. In 1976 this selection of currencies became mobile. Small shifts could take place when necessary. In 1983 the AUD became a floating currency. This means that the value of the dollar is determined by supply and demand. Initially, the Reserve Bank of Australia had no intention of intervening in the market, but intervention has since been deemed necessary, usually to support the price. FACTORS AFFECTING THE SUPPLY AND DEMAND OF AUSTRALIAN DOLLARS With a floating exchange rate, as in Australia, supply and demand factors largely determine the equilibrium price of the dollar. The exchange rate is sensitive to changes in both supply and demand, which can cause changes in the equilibrium exchange rate. Another factor that may affect the supply and demand of Australian dollars is market intervention by the Reserve Bank of Australia. DEMAND Demand for the Australian currency in the foreign exchange (Forex) market is a derived demand. It arises from demand for a country's exports of goods, services and resources. In simple terms, people who may have a demand for the Australian dollar could include: Foreigners looking to buy Australian exports International tourists visiting Australia International investors looking to buy Australian shares or property International businesses opening branches or expanding into Australia Speculators and investors Thatthey think the value of the Australian dollar will increase in the hope of making a profit. Demand for the Australian dollar will be affected by a number of factors. These factors are: The extent of financial flows into Australia. The extent of financial flows into Australia from investors wishing to invest in Australiathe need to convert their currency into AUD will influence the demand for the dollar. The level of capital inflow will be influenced by the level of Australian interest rates relative to overseas interest rates, as well as the level of confidence in the Australian economy. If Australia has relatively higher interest rates and stronger confidence, this will encourage capital inflows and increase demand for the AUD. Using this theory, the Australian dollar appears to be in a relatively strong position at the moment. Interest rates are starting to rise (the official interest rate was recently increased by 0.25 points to 4.5% and is expected to rise to 5.25% by September this year, with expected economic growth around 3.75% in 2002/03). confidence in future economic growth is the recent balance sheet. The 2002/03 budget published on 14 May 2002 was a deficit budget. This means that the government spent more than it earned. This is an injection of cash into the Australian economy and will stimulate economic activity and growth. Price Expectations Expectations of future AUD appreciation will increase demand for the AUD from speculators as they expect to profit from buying the dollar now and selling later at a higher price. Demand for Australian exports Demand for Australian exports varies for a number of reasons. One reason is changes in commodity prices. Another is the terms of trade. These two changes tend to have an immediate impact on the AUD. An increase in commodity prices and an improvement in the terms of trade are generally expected to improve the current account deficit (CAD). This will often result in an increase in the value of the AUD due to the expectation that the CAD will improve in the short to medium term. Demand for Australian exports is also influenced by the level of international competition and Australia's inflation rate compared to other countries. If Australian businesses are competitive in the world market and Australia's inflation rate remains low, it means Australian exports will be cheaper for foreigners, making them more attractive to buy. Changes in global income levels will also affect overseas demand for Australian exports. Demand for Australia's commodity exports, in particular, is highly dependent on the income levels of Australia's trading partners. When the world economy is in a period of recovery, demand and prices for Australian exports will increase. Also influencing global demand for Australian exports is simply the tastes and preferences of overseas consumers for Australian exports. An increase in demand for Australian dollars generally causes the value of the currency to appreciate. The page shows a supply and demand curve, which demonstrates an appreciation of the dollar. SUPPLY The supply of the Australian currency is also derived. It arises from demand by Australian residents for foreign goods, services and goods. People who might create a supply of Australian dollars are: Australians who want to buy imports from overseas Australian tourists going overseas Australian banks and companies who lend or invest money overseas various services from overseas such as the refund of loans or the payment of interest onloansSpeculators and investorsThe supply of Australian dollars will be influenced by a number of factors. These factors are: The magnitude of financial flows out of Australia The level of financial flows out of Australia will also be determined by domestic versus foreign interest rates, as well as international confidence in Australia and other economies. If Australian interest rates are relatively lower and confidence in the Australian economy deteriorates, capital outflow will increase, thus increasing the supply of AUD. At the moment, interest rates are at low levels, but are expected to rise in the near future as confidence and economic growth are relatively high. This means that there will be no large increase in the supply of Australian dollars. Price Expectations Speculators and investors in the foreign exchange market who expect the value of the AUD to decline will sell the AUD in order to minimize losses. This will increase the supply of AUD and contribute to the expected depreciation. Domestic Demand for Imports Australian importers purchasing from overseas need to sell AUD to obtain foreign exchange to pay for imports. The level of domestic income will largely determine the demand for imports. When the domestic economy is growing, production, employment and income increase, then the demand for imports will also increase, which in turn will increase the supply of AUD. If people have a higher income, they may choose to purchase goods from abroad that are considered prestigious. The domestic inflation rate and the competitiveness of domestic firms that compete with imports will also influence the level of import demand. If Australia's domestic inflation rate is higher and its businesses are relatively uncompetitive, imports will be cheaper than Australian-made products and demand for imports will increase. Additionally, Australian consumer tastes and preferences change over time and the desirability of Australian products increases. goods and services produced abroad will increase the supply of AUD on the foreign exchange market. When the supply of dollars increases, there is generally a depreciation in the value of the currency. THE ROLE OF THE GOVERNMENT IN THE EXCHANGE RATE The government can manage the Australian currency through the Reserve Bank of Australia (RBA). The RBA can intervene in the foreign exchange market and can implement government policies designed to influence the value of the dollar. Reserve Bank Intervention in the Forex Market The Australian exchange rate is generally left to float cleanly, with market forces determining its value. However, from time to time, the RBA intervenes in the foreign exchange market to influence the value of the exchange rate, thus dirtying the free float. The intervention can occur for various reasons. They are:1. If the exchange rate deviates too much from its long-run regular equilibrium path, there can be negative effects on economic conditions such as inflation, employment levels and gross domestic product.2. Intervention (as a buyer or seller of foreign currency) can help ease sentiment in the foreign exchange market resulting from excessive speculation.3. RBA authorities can also intervene to prevent excessive depreciation (which could lead to higher input prices and inflation), or excessive appreciation (which could lead to higher export prices and a loss of international competitiveness) and buy time to reevaluate economic policy. to the exchange rate Essentially, there are three policies that the Australian government (through the RBA) can adopt to try to influence the valueof the exchange rate in a floating system: The RBA can intervene directly in the market as a buyer or seller of foreign currency. This is usually done to smooth out the market and reduce what is considered excessive volatility caused by uninformed speculation. The RBA can intervene indirectly by changing the level of interest rates through its market operations. This will have the effect of altering the interest rate differential between Australia and the rest of the world. An increase in interest rates relative to overseas will encourage capital inflows and therefore increase demand for the Australian dollar. This action could also be taken to prevent further depreciation of the Australian dollar. A decline in Australian interest rates will encourage capital outflow and increase the supply of Australian dollars relative to demand. This action would prevent further appreciation of the Australian dollar. The government could use a mix of macroeconomic policies to increase or decrease the rate of economic growth in Australia relative to the rest of the world. ContractiveMonetary, fiscal, and industrial relations policies can reduce aggregate demand, including demand for imports, thereby increasing the value of the exchange rate. Alternatively, one would expect the use of expansionary macroeconomic policy to stimulate aggregate demand, including demand for imports relative to exports, increasing economic growth, but lowering the exchange rate. Direct Intervention The RBA's direct intervention in the foreign exchange market has potential implications for domestic liquidity. RBA intervention can be sterilized to offset effects on domestic liquidity and interest rates or unsterilized with interventions that affect domestic liquidity and interest rates. Sterilization occurs when the RBA offsets its intervention in the foreign exchange market by buying or selling the equivalent amount of government bonds, leaving the RBA's monetary liabilities unchanged. Intervention in the unsterilized foreign exchange market does not involve any compensatory purchase or sale of government bonds. An unsterilized sale or purchase of foreign currency will lead to a decrease or increase in the money supply and an increase or decrease in interest rates. The RBA has always undertaken a sanitized intervention. There are two ways to do this: Buy Commonwealth government bonds in its domestic operations Arrange a foreign currency swap, exchanging one currency for another in the current (spot) market and agreeing to reverse the transaction at a future date at a agreed price or exchange rate (futures market)Indirect interventionMonetary policy initiatives represent a more indirect way of influencing the exchange rate and are rarely used for this purpose. If the government wants to curb the rapid depreciation, it could increase demand for the AUD by raising interest rates. Higher interest rates will attract more foreign savings, which will need to be converted into AUD. This will increase demand for the AUD and put upward pressure on the exchange rate, however, this policy will generally only be effective for a limited period. It is unusual for the RBA to change interest rates in response to currency movements because the main objective of its monetary policy decisions is to influence the national economy. Sometimes exchange rate movements are so large that they can affect the stability of the economy or the level of inflation. An example of this occurred in April 2000. The RBA stated that one of the factors that prompted it to raise interest rates was the depreciation of the Australian dollar, which was increasing pressuresinflationary and putting low inflation at risk. This was the first time since 1986, when the RBA had openly adjusted interest rates in response to exchange rate movements. THE EFFECTS OF EXCHANGE RATE MOVEMENTSBoth depreciation and appreciation in the value of the Australian dollar have negative and positive effects. If a depreciation occurs, it increases the domestic price of foreign goods and reduces the foreign price of exports. If appreciation occurs, it lowers the domestic price of foreign goods and increases the foreign price of exports. DEPRECIATION The depreciation of the Australian currency has a number of positive effects. They are: In the long term, a depreciation of the exchange rate increases the competitiveness of the tradable goods sector (producers who compete with exports and imports) by making Australian goods and services cheaper and therefore more competitive than the same goods and services produced elsewhere 'abroad. This will help increase export earnings and reduce import spending. Overall, this will help improve the current account deficit (CAD). This theory is known as the J-curve theory. A depreciation could encourage higher levels of capital inflow into Australia as domestic assets become cheaper than their overseas counterparts. This can help reduce the level of external debt and increase foreign equity investment in Australia. A devaluation can lead to a structural change in the composition of the Australian economy, for example a shift towards export manufacturing and service industries. In addition to the positive effects mentioned above, there are also negative effects. These are: A depreciation of the currency can increase the cost of imports and reduce the price of exports in the short term. This can lead to a reduction in the income from the sale of a given volume of exports and an increase in the cost of a given volume of imports. Lower export income and increased import spending will increase the size of the CAD in the near term. A depreciation can often lead to a higher inflation rate. This will happen if monetary policy is unable to contain inflationary expectations. Since the 1990s, microeconomic policies have been adopted to dampen inflation and make the economy more flexible in the face of large currency shocks such as the 1997 Asian crisis. Examples of these policies include enterprise bargaining and national competition policy. The immediate effect of a depreciation of the dollar is to increase the value of the part of the net external debt relative to which the value of the AUD has depreciated. For example, if the AUD depreciates against the dollar, the portion of the foreign debt to the United States will increase in value. A depreciation of the AUD will increase the debt service ratio. The debt service ratio corresponds to interest repayments as a percentage of exports. Higher interest repayments can lead to a higher net income deficit and increase the size of the CAD. A large depreciation could lead to indirect intervention by the RBA to support the exchange rate by raising interest rates. This can lead to lower economic growth and investment, thus reducing employment and domestic confidence levels. APPRECIATION As with depreciation, appreciation has both negative and positive effects. Some of the positive effects include: Exchange rate appreciation reduces the cost of imports and increases the price of exports in the short term. This may result in an increase in export income and a reduction in expenditure on.