Exchange Rates The value of one country’s currency in terms of another country’s currency.The value of one country’s currency in terms of another country’s currency. Forces of demand and supply on FOREX (foreign exchange) markets determine the exchange rate when a country has a floating (flexible) exchange rate.Forces of demand and supply on FOREX (foreign exchange) markets determine the exchange rate when a country has a floating (flexible) exchange rate.

Depreciation decrease in value of currencydecrease in value of currency $1AUD= $1US$1AUD= $1US $1AUD=$0.90 US$1AUD=$0.90 US Why does a depreciation occur?Why does a depreciation occur? Use demand and supply diagramsUse demand and supply diagrams

Depreciation – positive effects Increase international competitiveness – export prices can fall and import prices can rise. The impact of this will depend on the price elasticity of demand for exports and imports. WHY?Increase international competitiveness – export prices can fall and import prices can rise. The impact of this will depend on the price elasticity of demand for exports and imports. WHY? CAD should improve if X growth increases.CAD should improve if X growth increases. Encourage foreign investmentEncourage foreign investment Increased economic growth rates.Increased economic growth rates.

Depreciation – negative effects Increases interest servicing costs for funds borrowed from overseas- valuation effect - increases CADIncreases interest servicing costs for funds borrowed from overseas- valuation effect - increases CAD Increases the foreign debt for those that have borrowed from overseas – valuation effectIncreases the foreign debt for those that have borrowed from overseas – valuation effect Increased domestic inflation as import prices increase.Increased domestic inflation as import prices increase. A large and sudden depreciation may prompt Central Bank intervention.A large and sudden depreciation may prompt Central Bank intervention. NOTE: an appreciation has the opposite positive and negative effects

Appreciation What is an appreciation? Why do currencies appreciate? What are the positive effects? What are the negative effects?

Summary Overall a depreciation is generally considered good by exporters because it increases international competitiveness and bad by those that have borrowed from overseas or are travelling overseas.Overall a depreciation is generally considered good by exporters because it increases international competitiveness and bad by those that have borrowed from overseas or are travelling overseas.

Role of Central Bank Central Banks intervenes in FOREX markets from time to time to stabilise a currency- this is called dirtying the float.Central Banks intervenes in FOREX markets from time to time to stabilise a currency- this is called dirtying the float. Direct Central Bank intervention can only be a short-termDirect Central Bank intervention can only be a short-term Central Bank intervention can also be indirect via domestic interest ratesCentral Bank intervention can also be indirect via domestic interest rates

Fixed or Managed exchange rates Some countries attempt to manage their exchange rates- Singapore and ChinaSome countries attempt to manage their exchange rates- Singapore and China The Central Bank buys or sells currency to maintain stability in the marketThe Central Bank buys or sells currency to maintain stability in the market Managed currencies tend to discourage currency speculatorsManaged currencies tend to discourage currency speculators

Revision CompleteComplete Exam Practice and Chapter review questions exchange rate revision exercises