Australian Exchange Rate

Analyse the effects of changes in the exchange rate of the Australian dollar (against other currencies) on the Australian economy.

Australia has adopted a floating exchange rate; the exchange rate is determined by the free play of market forces and not government intervention. An exchange rate is the price of any particular country’s currency in terms of another country’s currency. All trade and financial relationships between Australia and other countries are determined through the exchange rate which has a significant impact on Australia’s competitiveness and external stability. The Australian dollar is particularly impacted by fluctuations majorly attributed to speculative trade that occurs in Australian dollars. The Australian currency…show more content…
The size of financial flows depends heavily on the extent of Australian exports of goods and services. As more good and services are demanded from Australia, they must be paid for in the Australian dollar. Foreign consumers convert their currency to the AUD to pay for the goods or services, thus increasing the demand for the AUD and pushing the equilibrium price upwards, resulting in an appreciation of the AUD. Exports of goods and services from Australia is in a heavy relationship with international competitiveness of Australian firms. That is, the ability of firms in Australia to compete on the international market for the sale of goods and services. Increased international competitiveness will result in more demand of goods and services from Australian firms as they are cheaper compared elsewhere, resulting in more demand for the AUD thus appreciating the dollar. There, however, can also be a reverse effect. A high Australian dollar will make goods and services purchased from Australia relatively more expensive when compared with other countries offering the same goods/services. An example of this effect in today’s economy is the mining boom in Australia. Australia’s economy is sometimes referred to as a ‘two speed’ economy. A boom in the mining industry appreciates the dollar as foreign countries buy our minerals, however, this…show more content…
The exchange rate and balance of payments shift in close accordance with each other. If the value of imports increased, this result in a worsening of the current account deficit, as there is more money leaving Australia. As the money leaves Australia, there will be an increased supply of the AUD resulting in a depreciation of the exchange rate as importers must sell their Australian currency to pay for their foreign goods. The opposite is also true, if the volume of imports decreases, there will be a decrease in the volumes of AUD being traded, which will in turn appreciate the Australian dollar. As exemplified in the stimulus, an appreciation of the Australian dollar, however, can have adverse effects on volumes of imports and international competitiveness. For this, there is a possibility of some industries to struggle.

It is important to be able to measure the value of the Australian dollar for many reasons, that range from being able to make an informed business decision or, propose government initiatives and stances. A useful way of measuring the value of the AUD is through using the trade weighted index. The trade weighted index is a weighted average of a basket of currencies that reflects the importance of the sum of Australia's exports and imports of goods by country. The TWI is often used as one indicator of Australia's international competitiveness