Analyse_the_Effects_of_Fluctuations_on_the_Aud_for_the_Australian_Economy.

Analyse the effects of fluctuations of the AUD on Australia’s economy. A fluctuation in the exchange rate has profound effects on the Australian economy. Any slight movement, either up (appreciation) or down (depreciation), can have drastic, domino like effects. These effects will firstly be felt with importers and exporters, but slowly seep through the economy to influence the way in which the average person lives their life. In recent years, the main reason for the appreciation of the AUD has been the demand for Australian resources from overseas, and in particular China. China’s real GDP has expanded over six times whilst India’s has tripled. Their efforts to transform and increasingly industrialise their economy have required massive amount of raw materials, of which Australia has capitalised on. The high value of the AUD has been a result of large amounts of exports from the commodity sector, efficient production of primary products and its competitive advantage in the mining industry. The Australian dollar was floated in 1983, and is thus determined by the forces of supply and demand in the foreign exchange market. There are two ways in which the Australian dollar can move. Either it can appreciate, or depreciate. Each respectively, has their own advantages and disadvantages. An appreciation of the exchange rate acts to lower the domestic price of imports whilst raising the foreign price of exports. It has both, positive and negative effects on the Australian economy. However a distinction must be made between short term and long term effects when analysing them. The positive effects of an appreciation are as follows: * An immediate effect is that it reduces the level of net foreign debt that is denominated in other currencies. This means that an appreciation in the AUD will also decrease the debt servicing ratio. Lower interest payments on this debt could also lead a lower net primary income deficit and a thus a decrease in the size of the CAD. * In the short term, an appreciation lowers the price of imports and increases the price of exports. This can lead to a higher export income for the sale of an amount of exports. It will also reduce the net primary income deficit, which can, in turn, lower the size of the CAD also. * An appreciation may also lead to lower domestic inflation through lower import prices. This in effect raises the real incomes of consumers, who can improve their living standards through access to a greater amount and variety of cheaper imports as compared to domestically produced goods. Whilst there are many positive effects of an appreciation in value of the AUD, there are just as many negative effects. They are as follows: * In the short term, an appreciation may lead to higher unemployment as industries and firms operating in the export and import markets attempt to restructure to become more internationally competitive. * An appreciation can lead to a high level of capital outflow from Australia as domestic assets become more expensive and less attractive relative to foreign assets. This essentially means a possible decrease in FDI and portfolio investment within Australia. * In the long term, an appreciation of the exchange rate reduces Australia’s level of international competitiveness by making our goods more expensive relative to other countries. This can reduce export income and increase export expenditure, thus worsening the CAD. Consequently, a depreciation in the Australian dollar also has varying positive and negative effects for the Australian population. The positive effects of a depreciation are as follows: * A depreciation in the value of the Australian dollar may lead to structural adjustment. This structural adjustment would be undertaken with the aim to become more internationally competitive. In the 1980’s a depreciation in the relative value of the AUD, assisted the growth of manufactured and service exports, which rose by 25%. * The depreciation of the Australian dollar also may attract higher levels of capital inflow into the Australian economy as domestic goods and services become cheaper relative to foreign competitors. This can help to reduce the level of foreign debt and increase FDI and portfolio investment. * In the long run, a decrease of exchange rates enhances Australia’s international competitiveness by making Australian goods and services more price competitive. This helps to raise export income and reduce export expenditure, thus improving the CAD in the BOP. The negative effects are: * An immediate increase in the level of net foreign debt denominated in other currencies * In the short term, a raise in the price of imports and reduction in the price of exports. The often leads to lower export income and also raises the cost of a given volume of imports. Lower export income and higher import expenditure will also worsen the goods balance, and therefore also worsen the CAD. * A depreciation in the relative value of the Australian dollar will in turn lease to a higher debt servicing ratio . Higher interest payments overseas could leas to a higher net primary income deficit and worsen the CAD. * A depreciation may also lead to higher levels of domestic inflation, through higher import prices, if monetary policy unable to contain inflationary pressures. * A large or dramatic increase in the exchange rate could lead to RBA intervention to support the exchange rate through higher interest rates to reduce the demand for imports and to encourage capital flow. The RBA may also opt to make use of its dirty float system and buy Australian dollars in the market to tighten supply, therefore increase the exchange rate. An appreciation or depreciation in the relative value of the AUD can have wide influences on the general public. These influences are both positive and negative, and for every loser in the market, there is an equal winner. Over time this will favour the most structurally sound and competitive industries, which in turn creates more efficient use of production methods. M.Logan