NOTE: Free essay sample provided on this page should be used for references or sample purposes only. The sample essay is available to anyone, so any direct quoting without mentioning the source will be considered plagiarism by schools, colleges and universities that use plagiarism detection software. To get a completely brand-new, plagiarism-free essay, please use our essay writing service.
One click instant price quote
... he rest of the world. A rise in interest rates relative to overseas will encourage capital inflow and hence increase demand for the Australian dollar. This action might also be taken to prevent further depreciation of the Australian dollar. A fall in Australian interest rates will encourage capital outflow and increase the supply of Australian dollars relative to the demand. This action would prevent further appreciation of the Australian dollar.
The government may use a mix of macro-economic policies to increase or decrease the rate of economic growth in Australia relative to the rest of the world. Contractionary monetary, fiscal and industrial relations policies may reduce aggregate demand, including the demand for imports, thereby raising the value of the exchange rate. Alternatively, the use of expansionary macro-economic policy would be expected to boost aggregate demand, including the demand for imports relative to exports, raising economic growth, but lowering the exchange rate. Direct intervention Direct intervention by the RBA in the foreign exchange has potential implications for domestic liquidity. Intervention by the RBA can be sterilised to offset the effects on domestic liquidity and interest rates or un sterilised with intervention affecting domestic liquidity and interest rates.
Sterilisation occurs when the RBA offsets its foreign exchange market intervention by buying or selling the equivalent amount of government securities, leaving the monetary liabilities of the RBA unchanged. Un sterilised foreign exchange market intervention involves no offsetting purchase or sale of government securities. An un sterilised sale or purchase of foreign currency will lead to a fall or rise in the money supply and a rise or fall in interest rates. The RBA has always undertaken sterilised intervention.
There are two means of doing this: Buying Commonwealth Government Securities in its domestic operations Arranging a foreign currency swap, by exchanging one currency for another in the current (Spot) market and agreeing to reverse the transaction at a future date at an agreed price or exchange rate (futures market) Indirect intervention Monetary policy initiatives are a more indirect way of influencing the exchange rate, and are rarely used for this purpose. If the government wishes to curb rapid depreciation, it may increase the demand for AUD by raising interest rates. Higher interest rates will attract more foreign savings, which must be converted into AUD. This will increase demand for AUD and put upward pressure on the exchange rate, however, this policy will generally only be effective for a limited time. It is unusual for the RBA to change interest rates in response to movements in the currency because the primary focus of its monetary policy decisions is to influence the domestic economy. Sometimes the exchange rate movements are so large that they may affect the stability of the economy or the level of inflation.
An example of this happening occurred in April 2000. The RBA stated that one of the factors prompting it to raise interest rates was the depreciation of the Australian dollar, which was adding to inflationary pressures and putting low inflation at risk. This was the first time since 1986 when the RBA had openly adjusted interest rates in response to movements in the exchange rate.
If appreciation occurs, it lowers the domestic price of foreign goods and raises the foreign price of exports.
This theory is known as the theory of the J Curve. A depreciation may encourage higher levels of capital inflow into Australia as domestic assets become cheaper relative to their foreign counter-parts. This can help to reduce the level of foreign debt and increase foreign equity investment in Australia. A depreciation can lead to a structural change in the make-up of the Australian economy e. g. a shift to the manufacturing and services export industries.
Along with the above-mentioned positive effects, there are also negative effects. These are: A depreciation of the currency can raise the cost of imports and reduce the price of exports in the short term. This can lead to lower export volume income from the sale of a given volume of exports and raise the cost of a given volume of imports. Lower export income and higher import expenditure in the short term will increase the size of the CAD. A depreciation can often lead to a higher inflation rate. This will occur if monetary policy is unable to contain inflationary expectations.
Since the 1990 s micro-economic policies have been adopted to smooth out inflation and make the economy more flexible when dealing with large currency shocks such as the 1997 Asian crisis. Examples of these policies include enterprise bargaining and the national competition policy. An immediate impact of a depreciation in the dollar is to increase the value of the part of the net foreign debt to which the value of the AUD has depreciated against. e. g. If the AUD depreciates against the $US then the section of foreign debt to USA will increase in value.
A depreciation of the AUD will raise the debt-servicing ratio. The debt-servicing ratio is the 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 the RBA indirect intervention 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.
Some of the positive effects include: And appreciation of the exchange rate lowers the costs of imports and increases the price of exports in the short-term. This can lead to a higher export income and lower export expenditure. This will lead to a reduction in the size of the CAD. Appreciation may lead to lower domestic inflation rates due to the lower import prices. This should raise the real income of consumers who can then in return increase standards of living by being able to purchase a variety of imports at a cheaper price. An appreciation will reduce the value of the section of foreign debt to which the currency has appreciated.
If the value of the AUD rises relative to $US, Australias foreign debt to the USA will decrease. An appreciation will reduce the debt-servicing ratio. Lower interest repayments can lead to a higher net income deficit and decrease the size of the CAD. The negative effects of an appreciation of the currency are as followed: In the long term it will decrease the competitiveness of Australian producers in the tradable goods sector. Australias goods and services will become less price competitive and therefore less attractive to overseas buyers. The CAD would increase if this were to occur.
An appreciation could lead to higher levels of capital outflow from Australia. This is because Australian assets become more expensive and less attractive relative to goods and services produced overseas. This would decrease foreign equity investment in Australia. It could lead to higher unemployment rates as those industries that export restructure in an attempt to remain internationally competitive.
A dramatic appreciation might lead to a RBA indirect intervention to support the exchange rate by lowering interest rates to reduce the demand for Australian dollars. This could lead to high levels of economic growth and investment, causing domestic inflation levels to rise.
The Sydney Morning Heralds Economic Editor, Ross Getting, says that the American dollar is vastly overvalued and the Australian dollar undervalued. He says this is an imbalance and that the thing about imbalances is that theyre unsustainable: eventually they have to be, and will be, corrected one way or the other. It could be for this reason that the Australian dollar is starting to gain momentum and increase in value against all other major currencies, particularly the $US. Other reasons for the appreciation of the Australian dollar include the recent economic figures posted by the government showing Australia to be in a strong economic position, the recent budget deficit and the anticipated rise of interest rates.
Free research essays on topics related to: interest rates, foreign debt, positive effects, exchange rate, australian dollar
Research essay sample on Australian Dollar Interest Rates
