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How the exchange rate has been affected over the last 3 years

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Introduction

Exchange Rates Matt Cantatore Contents Intro 2 How the exchange rate has been affected over the last 3 years 2 Imports and Exports 3 World Commodity Prices 4 Level of Economic Activity 5 Australia's Inflation Rate 6 Intro In the world economy, every single country has its own currency which is used as legal tender for all domestic transactions. One cannot purchase a good in one country, with the currency of another. This is to say, that if we as Australians wish to purchase a good or service in Britain, we must pay in Pound Sterling - the Australian Dollar (AUD) would not be accepted. Therefore, the need to devise a conversion policy between currencies has arisen - to date, this conversion rate is known as the exchange rate. An exchange rate merely expresses the purchasing power of one currency in relation to another (for example, 1 AUD is worth 0.66 USD). (Alcorn 2003) How the exchange rate has been affected over the last 3 years As already mentioned, an exchange rate measures the purchasing power of a domestic currency. But how would one determine the exchange rate of a currency? ...read more.

Middle

Consequently, this would lead to a rightward movement in the supply curve of Australian dollars, leading to a depreciation in the value of the currency. (CHASS) Since 2000, slow declines in Australia's exports against growths in imports have not been a very positive sign for the Australian dollar. Whilst it has not realistically, this has had the effect of decreasing the value of the Australian dollar. Record Current Account Deficits have also not boded well for the AUD, which has maintained its strength through other factors (discussed hereunder). Arguably, however, the Dollar's strength in spite of this suggests that it may have been even stronger with a more solid import/export foundation. (RBA 2003) World Commodity Prices World commodity prices are determined by the market conditions of demand and supply on a global level. For example, if nuclear war was to break out worldwide and global demand for gas masks increased, the world price for gas masks would increase too, relative to the increase in demand. Similarly, if world supply of a particular good increases, its world price would decrease. (Alcorn 2003) Contrary to what one might expect, fluctuations in world commodity prices can have great influence of the Australian exchange rate. ...read more.

Conclusion

As a result of a higher CPI and hence relatively high prices, demand for Australian exports will be reduced. This will, again, decrease demand for and the value of the AUD. Over and above this, higher domestic prices will force consumers to seek commodity substitutes, which will, in many cases, be imports. A double-whammy effect can therefore be noted, as not only will demand for Australian exports decrease, but foreign imports will increase as well. This has the effect of both lowering demand for the AUD whilst increase the supply of it - not a very positive situation. (Alcorn's Notes 2003) Unfortunately, the situation mentioned above is the very grim situation facing Australian economists even to this day. At present point, Australian interest rates sit well above their trading partners, at around 4.75%. Other major countries around the world have the following, comparatively lower interest rates: United Kingdom 3.75% Canada 3.25% European Union 2.5% United States 1.25% Clearly, Australia's high interest rate leaves something to be desired in comparison to these other first world interest rates. One can hardly expect Australia to be competitive with America with an interest rate almost 4 times as large as it. This is, without a doubt, the most weakening factor of the Australian economy, and is the greatest threat to its exchange rate at present. (RBA 2003) ...read more.

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