Causes of a Depreciation in the Aud

ANALYSE THE CAUSES OF A DEPRECIATION IN THE VALUE OF THE AUSTRALIAN DOLLAR AND THE IMPACT OF A SUSTAINED DEPRECIATION OF THE CURRENCY ON THE AUSTRALIAN ECONOMY  

1.   Define exchange rate – the value of an economy’s currency against another economy’s currency. Outline what it is measured in – usually against the $US or Trade Weighted Index; compares Australian dollar against a regimen of Australia’s major trading partners. Also outline and distinguish between floating exchange rate and flexible peg/fixed exchange rate.

2.   Briefly identify the recent changes in the Australian exchange rate.

a.   TWI increased from 78 in early 2013 to 60.0 in september-2015, reflecting a depreciation of the Australian dollar relative to the weighted regimen.

3.   Analyze the causes of a depreciation in the Australian dollar. A depreciation is defined as a relative decrease in the value of the Australian dollar relative to another nation’s currency. It is caused by an decrease in demand for the Australian dollar, or increased supply of the Australian dollar.

a.   decreased demand for Australian exports contributes to a depreciation, as foreign buyers must purchase the Australian dollar in order to complete their transaction for their good/service.

i.   This was reflected in the lessening demand for Australian primary commodity exports from emerging economies, such as China and India - with export amounts decreasing by $4 billion between 2013 and 2014

ii.   Also caused by the deterioration in the Terms of Trade in Australia from high of 118.5 in third quarter of 2011 to 82.6 in second quarter of 2015 contributed by

Lower price of iron ore from early 2013 - $154 US per ton in early 2013 to $51.5 US per ton in mid-2015

b.   A decrease in Australian firms’ international competitiveness can make Australian exports less attractive to foreign buyers, which can cause a depreciation.

c.   decreased investments into the Australian economy which requires the conversion of their nation’s currency to the Australian dollar, from both Direct and Portfolio inflows.

i.   Australia’s decreasing investment opportunities, especially with the mining sector decreasing, has generally resulted decreasing level of Foreign Direct Investments into the economy, which has lowered the demand for the Australian dollar, contributing to a depreciation in the Australian dollar.

d.   increased instability in Australia diminishes foreign investor confidence, which can decrease financial inflows into the Australian financial sector.

i.   This has been may be caused by Australia’s inflation rate with Australia's inflation rate dropping from 3% in May 2014 to 1.3% in March 2015

ii.   Foreign investors perceiving Australia’s Current Account Deficit of around 4% of GDP as unsustainable, and hence investors may withdraw their funds and investments.

e.   Future expectations of a depreciation may decrease the level of short-term speculative investments into the Australian economy, which can further cause a depreciation.

4.   Analyses the impact of a depreciation on the Australian economy. A depreciation means that foreign investors/consumers would pay less using their currency in order to purchase a certain amount of $A to complete transactions.

a.   Thus, a depreciation would result in Australian exports becoming less expensive to foreign buyers.

This reflects an increase in international competitiveness for Australian exports, and could result in increased economic growth, as exports typically account for 20% of aggregate demand. Also, a depreciation means that Australian consumers have to purchase imports at a much higher price, discouraging the purchasing of imports, which reflects an improvement in the Balance of Goods and Services (BOGS), which can  contribute to a improvement of the Current Account Deficit. More expensive imports would have the positive effect of reducing import and overall national inflationary pressures, which consequently improves the standard of living in the economy.