Answer to Question #115201 in Macroeconomics for AIMAN

Question

(a) Briefly outline why the value of the Australian dollar may change against the US dollar in the (FOREX) foreign exchange market. Explain how the movement in the Australian dollar
would affect Australia’s export and import prices

Answer 1

The Australian dollar is the one if the most traded currency in the world.

Since Australia is the largest exporter of coal and iron ore, the movement of its currency will depend on commodity prices. For instance oil prices were low and both ore and coal prices slumped due to the Australian dollar weakening by 15 percent against the U.S. dollar.

The Australian dollar is affected by many factors that have an impact on the value of the Australian dollar and the United States dollar.

These factors include geographical factors such as the production of coal, iron ore, copper in Australia and political which affects the business environment.

The interest rate differences between the Reserve Bank of Australia and the Federal Reserve (Fed) will affect the value of these currencies .When the Fed intervenes in the open market activities to make the U.S. dollar weaker.

This happens because the Fed's actions move more U.S, dollars into bank circulation, thus increasing the supply of U.S. dollars impacting more pressure on the price of the currency, the Australian dollar will hold its value and the relative value of the pair increases due to a strengthening of the Australian dollar when comparing it to the U.S. dollar.

Exchange rate refers to the rate at which one currency will be exchanged for another. Exchange rates are important to Australia’s economy because they influences the financial flows between Australia and the rest of the world. The Austrian economy is affected by the exchange rates either directly or indirectly.

When it is affected directly the prices of goods produced in Australia are relative to other parts of the world but when it is affected indirectly it has an effect on inflation as the prices of goods and services produced in locally Australia and the rest of the world will have an impact on production and consumption. When the Australian dollar loses value, less foreign currency is required to purchase a given amount of Australian dollars. This makes Australian produced goods and services cheaper than before when compared with goods and services produced in other parts of the world.

An appreciation of the Australian dollar will result to Australian produced goods and services will being more expensive compared to goods and services produced in the world like in the United States.   

 Exchange rate depreciation on imported goods and services become relatively more expensive for Australian consumers and firms .This can make the Austrian residents to change their consumption patterns to demand more import leading to a decrease in the volume of exports.

 The resulting increase in volume of export and decrease in import volumes will increase national income in Australia. 

The indirect effects of an exchange rate on loss of value increases the volume of exports and reduces the volume of imports. This will tend to increase net exports and reduce the current account deficit.