Effect of exchange rates on key macroeconomic indicators

CURRENCY APPRECIATION REVISION CURRENCY APPRECIATION GOOD or BAD ?

REVISION CURRENCY DEPRECIATION

Can you explain this diagram? APPRECIATION Can you explain this diagram?

APPRECIATION CAUSE??? Increase in demand for AUD (shift from D to D1) Value of AUD (P) has increased (US$ 0.50 to $0.60) Quantity traded (Q) has increased (Q to Q1) CAUSE??? Increase in demand for Australian exports eg coal, aluminum, beef lamb

DEPRECIATION How is it different to the previous diagram?

DEPRECIATION CAUSES??? Decrease in demand for AUD (D to D1) Depreciation in the value of the AUD (to US$40) Quantity of AUD decreased (Q to Q1) CAUSES??? Slow down in global economic activity THEREFORE, decrease in demand for Aus exports Investors lack confidence in Aus economy

REMEMBER APPRECIATION Foreign goods (imports) are cheap Domestic goods (exports) are expensive DEPRECIATION Imports are expensive Exports are cheap

LEARNING OBJECTIVES Analyse the effect of changes (up and down) in the exchange rate on the key macro economic indicators by: - Analysing effect - Draw up a poster - Share ideas - Peer Assess

MACROECONOMIC INDICATORS Low Inflation (measured by CPI or real GDP) High Economic Growth (GDP) Low Unemployment (unemployment rate) Trade Balance (X-M)reflected in BOP) Let’s look at these!

GROUP TASK TASK Evaluate the effects of a change in exchange rate on: Inflation Economic Growth Unemployment Trade Balance Interesting fact GROUP TASK 4 GROUPS Discuss using diagrams Draw up a poster Provide feedback to class Evaluate (Rubric)

INFLATION CURRENCY DEPRECIATION Makes exports cheaper and imports expensive BAD? If firms rely on imported resources (FOPs) AS moves to the left GOOD? For exports AD moves to right … INFLATION (cost push & demand pull) increases

INFLATION

ECONOMIC GROWTH Related to net exports (affect AD and AS) CURRENCY DEPRECIATION Increase in net exports, increase in AD and increase in real GDP THEREFORE decrease in unemployment BUT may be short term because of inflationary pressure LT = increase (X) =increase (I) + real GDP Also decrease in unemployment and inflation possible

ECONOMIC GROWTH

UNEMPLOYMENT CURRENCY DEPRECIATION Increase in net exports = Increase AD Unemployment decreases as real GDP increases BUT LT …..may have inflationary pressure

UNEMPLOYMENT AS DEPRECIATION domestic firms will benefit from increased AD AD1 sales. Real GDP This may lead to job creation and lower unemployment, especially in exporting industries. The increase in X-M will help increase Aggregate Demand (AD) and therefore lead to higher economic growth

TRADE BALANCE CURRENCY DEPRECIATION = increase exports decrease imports THERFORE, Decrease trade deficit CURRENCY APPRECIATION Worsens BOT (imports increase and exports decrease) THEREFORE, Decrease in income, increase in unemployment

What can we conclude?

What are the main functions of a foreign exchange market? QUESTION What are the main functions of a foreign exchange market?

Functions of Foreign Exchange Markets

FUNCTIONS OF F/E MARKET TRANSFER Conversion of one currency to another Transfer purchasing power Done through credit instruments: - foreign transfers - bank drafts - foreign bills

FUNCTIONS OF F/E MARKETS CREDIT Allow the provision of credit ( Nationally and internationally) Use: - Bills of exchange - are used in international payments, (a credit for about 3 months, till their maturity, is required). The foreign exchange market carries out payments internationally by clearing debts in both directions

FUNCTIONS OF F/E MARKETS HEDGING Safeguarding against changes in exchange rates (losses or gains) USE - forward contracts (can buy or sell FE at a fixed future date at a given price)

FORWARD CONTRACTS A forward contract is a contract to buy or sell foreign exchange against another currency at some fixed date in the future at a price agreed upon now. No money passes at the time of the contract. But the contract makes it possible to ignore any likely changes in exchange rate.