Australian Exchange Rate-Free-Samples-Myassignmenthelp.com

Questions: 1. If investors expect an increase in the interest rate paid on US deposits, how the Australian exchange rate will change? Explain. 2. If there is a permanent exogenous decrease in the US money supply, please discuss its short run and long run effects on the US and Australian money markets, and the exchange rate, US$/AU$. 3. On 22nd of March 2018, US Federal Reserve raised interest rate by 0.25%. Correspondingly, however, Australian dollar (AU$) appreciated relative to the US dollar. Please search relevant information and use what you have learnt from this unit to explain this AU$ appreciation. Answers: 1.According to the investment theory, if there is rise in interest rate, then the aggregate private investment level will tend to rise (Friedman 2017). Considering the given scenario, where US and Australia is indulged in investment, if there is expected rise in return in US deposits, then more people from Australia will investment in the US banks. With rise in the investment flow from Australia to US market, there will be enhanced demand scenario in front of the US dollar and on the other hand demand of the Australian dollar will subsequently fall (Keynes 2016). With lower demand of the Australian dollar exchange rate of the country will eventually get depreciated. Thus if there is future expectation that interest rate paid on US deposits will increase, then it will depreciate the Australian exchange rate. Figure 1: Exchange rate framework Source: (Created by Author) Figure 1 highlights the exchange rate framework. From the above figure it can be seen that initial equilibrium between the AUD and USD takes place at point 1, where the dollar rate of return is R$. Now, if there is expectation regarding the rise in the dollar return from the US deposits, then it will force the expected return curve to move upward (marked with the blue expected return curve). Hypothetically if it is assumed that new equilibrium takes place at point 2, then it will enhance the exchange rate on behalf of the US. Contrary to this, exchange rate of the AUD will subsequently fall from its initial point (Point 2017). Thus, to conclude it can be said that if there is expected rise in interest rate paid on US deposits, then it will depreciate the Australian dollar. 2.Decrease in money supply cause differently to the economy on different period. For instance if there is decrease in exogenous money supply then it would reduce the money velocity and will lead to appreciation of USD compared to the other currency (Haberler 2017). Considering the given scenario of money supply if there is decrease in money supply in the US, then it would cause differently on different scenario. Appreciation of the money supply will reduce the export of the US goods in Australian economy and in long run it would hamper the US exchange depreciating the USD/AUD exchange rate. With reduced money supply, however, in long run the scenario will be different. For instance if there is appreciation in the exchange rate through exogenous decrease in the US money supply, then US regulatory agency will consider the monetary reformation (Bahmani and Saha 2015). Government of US would increase the money supply through monetary reformation policy. Increase in money supply will infl uence the aggregate demand and in addition it will reduce the interest rate. Through reduction in the interest rate in long run economy of US will adjust the exchange rate with Australian economy which will enhance the bilateral trade. On the other hand Australian money market will take contractionary monetary plan that can help the economy to withstand higher investment from US economy. Figure 2: Money supply framework Source: (Created by Author) Considering the figure 2, it can be seen that if there is permanent decrease in US money supply, then it would lead the money supply curve downward causing change in equilibrium from 1 to 2. From the second panel of the figure 2, it can be seen that money supply in US economy will increase in long run and in short run it will lower than the US real money supply requirement. On the other hand decreased exogenous money supply will lead to fall in the exchange rate of USD/AUD. Interest rate of the US economy will fall and through fall in the interest rate of the US economy, investors will invest in more amount in the Australian economy (Serrano and Summa 2015). This rise in investment in the Australian economy will appreciate the countrys economy while it would deteriorate the trade for the Australia too. Thus, if there is reduction in the exogenous money supply in US economy, then it would reduce the trade balance for both the countries while enhancing the exchange rate higher for the Australia and US too. On the other hand money market of the US will suffer from reduced liquidity while Australian money market will face boom in liquidity in short run, however, in long run it both the economies will take monetary policies to gauge the situation. 3.General theory of interest rate and inflation highlights that, if there is rise in interest rate in one trade participating nation, then it will lead to depreciation of exchange rate of another countrys exchange rate (Grauwe 2018). However, if there is rise in exchange rate in one trade participating nation and the other appreciates then it can be seen that the government of the other trade participating nation has been able to signaling the investors that there will be expected exchange rate appreciation of the countrys currency. In turn it later lead to appreciation of the spot exchange rate of the country that helps it to have better trade situation. Considering the case of Australia and US, it can be seen that long are those days gone, when Australian policy makers used to mechanistically follow the US Fed principles (Chung 2018). Australian now being driving on its economic growth for last 27 years, it is strong enough in front of small Fed hikes like mentioned in the given question (McCombie and Thirlwall 2016). Contrary to this US economy has been recently ailing from the 2008 Global Financial Crisis, which caused a crippling blow to the economy (Tenreyro and Thwaites 2016). Interest rate of the US economy during those days were lowest among all developed nations that allowed it to face currency depreciation and the economy was tremendous turmoil. However, contrary to this, Australian economy is stable enough since last three decades that has provided it much needed strength to withstand against ailing USD. According to the (Haberler 2017), appreciating the AUD is essential for the countrys regulatory authority in order to hold the rebalancing mining investment and in addition to this cost of borrowing can be affordable with the appreciated AUD. Thus, though there has been rise in the interest rate in US, Australian dollar yet has been appreciated. References: Bahmani-Oskooee, M. and Saha, S., 2015. On the relation between stock prices and exchange rates: a review article.Journal of Economic Studies,42(4), pp.707-732. Chung, F. (2018).What the US rate rise means for Australia. [online] NewsComAu. Available at: https://www.news.com.au/finance/economy/australian-economy/what-the-us-rate-rise-means-for-australia/news-story/f5377d654039b5a14457f6df561e6e1b [Accessed 8 Apr. 2018]. De Grauwe, P., 2018.Economics of monetary union. Oxford university press. Friedman, M., 2017. Quantity theory of money.The New Palgrave Dictionary of Economics, pp.1-31. Haberler, G., 2017.Prosperity and depression: A theoretical analysis of cyclical movements. Routledge. Keynes, J.M., 2016.General theory of employment, interest and money. Atlantic Publishers Dist. McCombie, J. and Thirlwall, A.P., 2016.Economic growth and the balance-of-payments constraint. Springer. Pigou, A., 2017.The economics of welfare. Routledge. Serrano, F. and Summa, R., 2015. MundellFleming without the LM curve: the exogenous interest rate in an open economy.Review of Keynesian Economics,3(2), pp.248-268. Tenreyro, S. and Thwaites, G., 2016. Pushing on a string: US monetary policy is less powerful in recessions.American Economic Journal: Macroeconomics,8(4), pp.43-74.