The Australian Exchange Rate

The Australian Exchange Rate

Introduction: What factors affect the demand and supply of Australian dollars in the foreign exchange markets? Distinguish between the possible causes and effects of 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 Australia’s, supply and demand factors largely determine the dollar’s 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 Australia’s currency in the foreign exchange market (Forex) is a derived demand. It is derived from the demand for a country’s 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.