1. Chapter 14 The exchange rate

2. Lecture Plan Exchange rates: definition and brief Australian history
Effects of currency appreciation/depreciation on Australia’s foreign trade
Determination of exchange rates
Terms of trade changes: causes and effects 2

3. Foreign Exchange Rates
Exchange rate = The price of one currency in terms of another, e.g. A$1 = US$0.7500, or US$1 = A$1.3333
Appreciation/depreciation
Trade-weighted index (TWI)
May = 100
June 1994:
January 1998:
September 2001:
October 2003: 3

4. The Australian Exchange Rate
Fixed exchange rates
Pegged to the Pound sterling (prior to December 1971)
Pegged to the US dollar (December 1971 to September 1974)
Pegged to a TWI (September 1974 to November 1976)
Managed float (TWI + Government):
November 1976 to December 1983
Independently floating exchange rates:
Since December 1983, with some RBA intervention (‘the dirty float’)

5. Relationship Between Fixed Exchange Rates, BOP and Money Supply
Fixed exchange rate of the A$
Balance of payments (BOP) effect
Money supply volume
Under equilibrium
SURPLUS
Above equilibrium
DEFICIT

6. Effects of A$ Appreciation/ Depreciation on Imports
Computer import price (US$/tonne): US$1500
Exchange Rate
(A$1 = …)
Australian importer pays
Exchange rate effect
( + / – )
US$0.75
A$2000
US$0.90
A$1600
– A$400 (– 17%)
US$0.60
A$2500
+ A$500 (+ 25%)

7. Effects of A$ Appreciation/ Depreciation on Exports
Beef export price (US$/tonne) = US$1000
Exchange rate
(A$1 = …)
Australian exporter
receives
Exchange rate effect
( + / – )
US$0.75
A$1333
US$0.90
A$ 1111
– A$222 (– 17%)
US$0.60
A$1666
+ A$333 (+ 25%)

8. Determination of Exchange Rates
Price S D E
US$0.75
Quantity of $A 8

9. Effects of Exchange Rate on BOP
Demand for A$
comprises of all BOP
CREDIT entries e.g.
Exports (goods)
Exports (services)
Capital inflow (FDI in
Australia)
Supply for A$
comprises of all BOP
DEBIT entries e.g.
Imports (goods)
Imports (services)
Capital outflow (Australian FDI abroad)

10. Main Factors for the Value of the Australian Dollar
World economic growth and the economic situation in the United States, Europe, Japan and other Asian countries
World demand for commodities
Australian real interest rates
Special interest for foreign portfolio investors in Australia 10

11. Terms of Trade TTI > 100 Favourable TTI < 100 Unfavourable
TTI = Unchanged 11

12. Terms of Trade (2000–01 = 100)
Source: ABS Catalogue

13. Causes and Effects of Changes in Terms of Trade
Causes of deteriorating terms of trade
Export prices
Import prices
Exchange rate movements
Effects
On the current account
On the exchange rate
On economic welfare