Since Australia is heavily dependent on the export of commodity products, the prices of commodity are therefore particularly significant to the value of the AUD. Many commodities are inputs for secondary industry; hence commodity prices tend to fluctuate with the growth in world manufacturing. Strong growth in manufacturing industries creates higher demands for commodities needed for their production, and thus price of these commodities will rise. However some commodity goods are not used to manufacture other goods, so their prices will decrease These changes in commodity prices alter the value of the Australian dollar over time. Higher commodity prices due to higher demand increases Australia’s export earnings and therefore increase demand for the AUD. However if commodity prices fall, export earnings will decrease and thus the AUD will depreciate.
Trade results also alter the balance of the demand and supply of the AUD and trigger depreciation or appreciation. Performance of the Current account balance, which includes goods, service, incomes and current transfers accounts, measures our trade results. Over the past few decades Australia's net incomes and transfers results have been a consistent downward force on the AUD. However the balance on the Goods and Services accounts have fluctuated in the same time period. Our balance on goods was weak when our export commodities were hampered by droughts whilst imports of manufactured goods continued to increase in price. However it improved when interest rates were high, which discouraged spending on imports, as well as when AUD was weak like in that of 2000/01, which enhanced the competitiveness of our exports and hence increased the export income. Our Current Account deficit tends to grow in periods of strong economic growth and decline in periods of slow economic growth. Hence cyclical changes in the global business cycle promote the fluctuation of the AUD.
Speculators are also an important influence on Australia's exchange rate. Speculation is often of a volatile nature. When speculators expect AUD to appreciate they sell more foreign currency to buy more AUD in the hope of selling it at a higher price in the future. However if it is expected that AUD will depreciate, speculators will sell AUD to minimise losses and hope to gain profit in the relative appreciation of another currency. When these expectation change, so does the value of the AUD as the demand and supply of it changes. When profit opportunities, interest rates, commodity prices and/or trade results appear favourable, there is a likely appreciation of the AUD as more become demanded. But when these factors appear unfavourable, there is a likely appreciation of the AUD since less will be demanded and more will be supplied.
There are many effects of exchange rate fluctuations on the economy. Both appreciation and depreciation of the AUD has positive and negative impacts on the Australian economy. Both have significant influences in areas of the tradable goods sector, non-tradables, employment and investment, inflation, government economic policy and international competitiveness. Some of the impacts of appreciation or depreciation are of a short term nature, while others are long term effects.
In the long run, positive effects of a depreciation of the dollar include an improvement in the international competitiveness of the tradable goods sector. Both export and import-competing industries will benefit. When Australian goods and services become relatively more competitive, export incomes would increase, while import spendings would decrease since imports become relatively more expensive. This will encourage export production and production in import-competing industries, which will rise the demand for the factors of production required ie. rise in employment and further increase national incomes, savings, investment and aggregate demand for other products as well as improve the current account deficit (CAD) in the balance of payments. A depreciation may also induce higher levels of foreign investment into the domestic economy since domestic assets become cheaper. This reduces foreign debt and increases foreign equity investment in Australia. Higher levels of investment may also provide stimulations to the growth of the domestic economy. Moreover depreciation of the currency may also lead to structural adjustments in industry. For example in the late 1980s to early 1990s it has assisted in the development of the manufactured and service exports.
Apart from the benefits of depreciation there are also some disadvantages. In the short run, a depreciation raises the cost of imports and reduces the price of exports. This may reduce the revenue of export industries if the products are price inelastic. It will then worsen the goods balance and further deteriorate the size of our CAD. Higher import prices as a result of depreciation may lead to imported inflation. This may lose the confidence of entrepreneurs as future profit levels become uncertain, and hence investment decreases. The government by means of contractionary stances in fiscal and monetary policies and relevant microeconomic policies such as enterprise bargaining and national competition policy controls the possibility of inflation. Another significant negative effect is the deterioration in foreign debt denominated in foreign currencies against which the AUD has depreciated. As a result, the debt-servicing ratio would increase which could lead to higher net income deficit, and furthers deterioration in the Current Account.
The effects of an appreciation are directly opposite to that of a depreciation. Its advantages are the disadvantages of depreciation and it disadvantages are the advantages of depreciation. In the short run it will raise the revenue of exports and reduce the cost of imports if their are price inelastic. This will improve the goods balance and decrease the CAD in the balance of payments. An appreciation may also lead to lower domestic inflation as price of imports become lower. This will raise the real income of consumers and hence improve their living standards. Also, the reduction of the need to restrain inflation would permit government to take more positive macroeconomic policies. Furthermore, foreign debt will be reduced as will the debt servicing ratio since interests become lower in foreign countries as a result of the increased value of the Australian dollar.
However, there are many negative effects of an appreciation of the dollar. In the long run, an appreciation reduces the international competitiveness of export industries and import-competing industries. This would then reduce export income and increase import expenditure in the long run, thereby worsening the CAD. The downturn in production for exports and import-competing industries has negative implications for the circular flow of the economy as production will be reduced and unemployment increased. Investment will also be adversely affected as domestic assets become more expensive and foreign assets become relatively more attractive. This will lead to capital outflow and decrease equity investment in Australia. These effects will put downward forces on the development of the economy.
In conclusion, many factors contribute to the fluctuation of the exchange rate in the Australian economy, which are usually changes in the foreign or domestic market conditions. These factors include investment prospects related to differentials in interest rates between foreign and domestic economies, commodity prices and trade results that determine our balance of payments, speculations that are of a volatile nature and which may promote appreciation or depreciation dramatically, and world conditions that determine many of the changes in the formerly mentioned factors. These give rise to frequent fluctuations of the AUD, which may impact the domestic economy in a positive or negative manner. Both an appreciation and a depreciation of the dollar has short-term and long-term effects on the economy. Negative impacts hamper the growth of the economy and decrease the living standard of the people in the country. Positive impacts on the other hand, promotes economic growth and development and enhances the standard of living of the people engaged in the economy. Fluctuations of the dollar therefore, have definite and significant influences on the workings of the economy.
