EXCHANGE RATES ESSAY

Topics: Inflation, Macroeconomics, Investment Pages: 2 (1131 words) Published: July 20, 2015
Exchange rates are the value of one currency with respect to another, for the purpose of conversion. They affect investment levels, via the cash rate and values of domestic assets; trades, via prices and the terms of trade (TOT); liabilities, via currency appreciation or depreciation and the valuation effect, and trades. Exchange rates are influenced by government policies in the short term and market forces in the long term. Since the Australian dollar (AUD) was floated in 1983 it has experienced an appreciating trend; however, in recent years the AUD has depreciated from its mining-boom highs due to expansionary monetary policy and weaker economic outlooks. Prior to the 1980s, Australia’s exchange rate system was under a fixed system, whereby the government determines the value of the currency in terms of a fixed value of another currency or a basket of currencies. In 1983, the exchange rate system began to operate under a floated system in which there is no government intervention and the value of the AUD is determined by market forces. For instance, an increase in supply of AUD depreciates the currency and an increase in demand appreciates the currency. Under a floated system, the exchange rate also correlates with the cash rate; an increase in the cash rate increase demand for AUD thus appreciating the currency, whilst a decrease in the cash rate also decreases supply, effectively depreciating the currency. The demand and supply for AUD are foreign investment levels, expectations and trades. Foreign investors must hold AUD to invest in Australia, thus high foreign investment levels results in high demand for AUD which appreciates the currency. Secondly, if people predict that the AUD will appreciate, then the demand for AUD increases and appreciates the currency; whereas the expectation that the AUD will depreciate will induce people to sell the currency, increasing supply of AUD and depreciating the currency. Moreover, demand for AUD will increase,...
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