Australia and its exchange rate

Essay by matt88m May 2006

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Exchange rates play a key role in the relationships between individual economies within the context of the global economy, as all trade and financial flows between nations are mediated through exchange rates. With respect to Australia, the foreign exchange rate is simply the price at which the domestic currency exchanges for another foreign currency, and the conversion of these currencies takes place on the FOREX market where through market forces of demand and supply, buyers and sellers determine the equilibrium exchange rate price. Conversely, in the case of a fixed currency, the Government and its representatives are also able to determine the exchange rate price of one country in terms of another. Australia operates under a flexible exchange rate where acting market forces determine the exchange rate price, although the Reserve Bank can, and has so in the past 'managed' the Australian exchange rate in order to smooth out large fluctuations in the value of the AUD.

There are several factors which can affect the exchange rate, and depending on whether the AUD appreciates against other currencies or depreciates will determine the effects on the Australian economy and how well it performs in relation to other nations in the global economy.

The value of the AUD at any one time is the equilibrium value, however, this equilibrium is subject to fluctuations as buyers and sellers of currencies change their preferences. Demand for AUD is represented by those willing and able to buy AUD, and is affected by several factors including the size of financial flows into Australia from foreign investors who wish to invest in Australia, which itself is determined by the level of interest rates relative to overseas. Also, the demand for Australian exports creates greater demand for AUD as foreign currencies first need to be converted into AUD...