Example research essay topic: Supply And Demand Australian Dollar - 1,666 words

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What factors affect the demand and supply of Australian dollars in the foreign exchange markets? Distinguish between the possible causes and effects of a currency depreciation and a currency appreciation on the Australian economy. What forces have come into play, if any, in the past four months that have affected the value of the Australian dollar? Exchange Rate: The rate at which one unit of domestic currency is exchanged for a given amount of foreign currency A BRIEF HISTORY OF THE AUSTRALIAN DOLLAR Until 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 became pegged to the US dollar instead. These currencies were fixed currencies, which meant that the Australian currency would only change value when a major world currency also changed. This system lasted only until 1974 when the AUD became pegged to a trade-weighted selection of other currencies. This was still a fixed currency. In 1976 this selection of currencies became moveable. Small shifts were able to take place when needed.

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 was not intended to intervene in the market however since then it has been deemed necessary for intervention to take place, usually to prop up the price. FACTORS AFFECTING SUPPLY AND DEMAND OF AUSTRALIAN DOLLARS With a floating exchange rate, such as Australias, supply and demand factors largely determine the dollars equilibrium price. The exchange rate is sensitive to changes in both demand and supply, which can cause changes in the equilibrium exchange rate.

Another factor, which can affect the supply and demand of Australian dollars, is intervention in the market by the Reserve Bank of Australia. DEMAND The demand for Australias currency in the foreign exchange market (Forex) is a derived demand. It is derived from the demand for a countrys exports of goods and services and its assets. In simple terms, people who may have a demand for the Australian dollar could include: Foreigners wanting to purchase Australian exports International tourists visiting Australia International investors wishing to purchase Australian shares or property International firms setting up branches or expanding in Australia Speculators and investors who think the value of the Australian dollar will rise in hope of making a profit. The demand for the Australian dollar will be affected by a number of factors. These factors are: The Size of financial flows into Australia The size of financial flows into Australia from investors who wish to invest in Australia and need to convert their currency into AUD will affect demand for the dollar. The level of capital inflow will be affected 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, then this will encourage capital inflow and increase demand for the AUD. Using this theory, the Australian dollar at the present looks to be in a relatively strong position. Interest rates are beginning to rise (official interest rate has recently been risen 0. 25 points to 4. 5 % and is expected to raise to 5. 25 % by September this year, with economic growth expected to be around 3. 75 % in 2002 / 03. ) Also increasing the confidence in future economic growth is the recent budget. The 2002 / 03 budget released on 14 th May 2002 was a deficit budget. This means that the government has spent more than it has earned. This is an injection of money into the Australian economy and will stimulate economic activity and growth.

Price Expectations Expectations of a future appreciation of the AUD will increase the demand for the AUD by speculators as they expect to make a profit from buying the dollar now and selling at a later date at a higher price. The Demand for Australian Exports The demand for Australian exports varies for a variety of reasons. One reason is changes in commodity prices. Another is the terms of trade. These two variations tend to have an immediate impact on the AUD. A rise 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 because of the expectation that the CAD will improve over the short to medium term. The demand for Australian exports is also influenced by the level of international competition and the Australian inflation rate relative to other countries. If Australian firms are competitive in the world market and Australias inflation rate remains low, it means that Australias exports will be cheaper to foreigners, making them more attractive to buy. Changes in world income levels will also influence the overseas demand for Australian exports. The demand for Australias commodity exports in particular are highly dependent on the levels of income of Australias trading partners. When the world economy is in a period of upturn, demand and prices for Australian exports will rise.

Also affecting world demand for Australian exports are 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. A supply and demand curve is shown over the page, demonstrating an appreciation of the dollar. SUPPLY The supply of Australias currency is also derived. It is derived from the demand of Australias residents for foreign goods, services and assets. People who could possibly create a supply of Australian dollars are: Australians who want to buy imports from overseas Australian tourists going overseas Australian banks and firms lending or investing money overseas Australians paying for various services from overseas such as repaying loans or paying interest on loans Speculators and investors The supply of Australian dollars will be affected by a number of factors. These factors are: The size of financial flows out of Australia The level of financial flows out of Australia will also be determined by the domestic interest rates relative to overseas as well as international confidence in Australia and other economies.

If Australian interest rates are relatively lower and the confidence in the Australian economy has deteriorated, capital outflow will increase, thus increasing the supply of AUD. At the present, interest rates are at low levels, however they are expected to rise in the near future as economic confidence and growth are relatively high. This means there will not be a 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 decrease will sell AUD so as to minimise losses. This will increase the supply of AUD and contribute to the anticipated depreciation. The domestic demand for imports Australian importers who buy from overseas need to sell AUD in order to obtain foreign currencies to pay for the imports.

The level of domestic income will largely determine the demand for imports. When the domestic economy is growing, output employment and income are rising, so the demand for imports will also rise which will then increase the supply of AUD. If people have more income they may choose to purchase goods from overseas which are considered to have prestige. The domestic inflation rate and competitiveness of domestic firms that are in competition with imports will also influence the level of demand for imports. If Australias domestic inflation rate is higher and its firms are relatively uncompetitive, then imports will be cheaper than products produced in Australia and demand for imports will rise. Also, tastes and preferences of Australian consumers change over time, and an increase in the desirability of goods and services produced overseas will increase supply of AUD on the foreign exchange market.

When supply of the dollar increases, there is generally a depreciation of the value of the currency. THE GOVERNMENT ROLE 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 allowed 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 float. Intervention may take place for a variety of reasons. They are: 1.

If the exchange rate deviates too much from its smooth long-run equilibrium path, there can be adverse effects on economic conditions such as inflation, employment levels and Gross Domestic Product. 2. Intervention (as a buyer or seller of foreign exchange) may help to smooth the sentiment in the foreign exchange market resulting from excessive speculation. 3. RBA authorities may also intervene to prevent excessive depreciation (which could lead to higher input prices and inflation), or excessive appreciation (leading to higher export prices and a loss of international competitiveness) and buy time to re-evaluate economic policy. Government Policies Relating to the Exchange Rate Essentially, there are three policies that the Australian government (through the RBA) can do to try and affect the value of the exchange rate under a floating system: The RBA can intervene directly in the force market as a buyer or seller of foreign exchange. This is usually done to smooth out the market to reduce what is deemed to be excessive volatility caused by misinformed speculation.

The RBA may 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 t...

Research essay sample on Supply And Demand Australian Dollar