Importance Of The Exchange Rate In Australia's Economy

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The exchange rate is the value of one currency for the purpose of one conversion to another. These transactions occur in the FOREX market and is considered floating when the exchange rate is determined by the interaction between demand and supply. For this reasons, exchange rate movements have a significant impact on international competitiveness, trade flows, investment decisions, inflation and many other factors in the economy.

Under Australia’s floating exchange rate system, the value of the currency is determined by the interaction of the forces of demand and supply In the market place which determine an equilibrium value for the currency. Demand for the Australian dollar is determined by the perceptions of speculators about future $A
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An increase Australia’s domestic interest rate is a major factor in the appreciation in the exchange rate. By manipulating interest rates, central banks exert influence over both inflation and exchange rates. Higher interest rates offer lenders a higher return relative to other countries. The impact of higher interest rates is mitigated, however, if a country’s inflation Is much higher than other countries, or if additional factors serve to drive their currency value down. Furthermore, a country with a consistently lower inflation rate exhibits a rising currency value, as purchasing power increase relative to other currency’s. Australia inflation rate experienced a decrease of 1.7% to 1.3% from the last quarter of 2015 to the first quarter of 2016. Reflecting our relatively low exchange rate of 0.72 relative to the USD. A country terms of trade is a ratio comparing export prices to import prices. If the price of a country’s export price rises by a greater rate than that of its important, its TOT has favourably improved, which tends to show currency appreciation. In contrast a depreciation of the exchange rate would have to opposite effects explained …show more content…
The effects of an appreciation can be both good and bad for the economy. By increasing the value of the $A in terms of other currencies, Australia’s exports become more expensive on world markets, therefore more difficult to sell, leading to a decrease in export income and a deterioration in Australia’s CAD in the medium term. Moreover, foreign investors will find it more expensive to invest in Australia, generally leading to lower financial inflows. However, financial inflows may continue if foreign investors expect the currency to keep rising. Though an appreciation in exchange rates relatively reveals many negative effects it does outline a few positive effects. Australian consumers enjoy increased ‘purchasing power’ – they can buy more overseas produced good and creating a larger incentive to travel. Secondly, an appreciation decrease interest servicing cost on foreign debt because Australians can buy more foreign currency with AUD. Due to any movement in the value of AUD has both positive and negative effects on the balance of payment, it is arguable the true forces of supply and demand create a stable exchange

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