Australian Exchange Rate Essay Research Paper What — страница 3

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?cleanly?, with market forces determining its value. However, from time to time, the RBA intervenes in the foreign exchange market to influence the value of the exchange rate, thus ?dirtying? the float. Intervention may take place for a variety of reasons. They are: 1. If the exchange rate deviates too much from its smooth long-run equilibrium path, there can be adverse effects on economic conditions such as inflation, employment levels and Gross Domestic Product. 2. Intervention (as a buyer or seller of foreign exchange) may help to smooth the sentiment in the foreign exchange market resulting from excessive speculation. 3. RBA authorities may also intervene to prevent excessive depreciation (which could lead to higher input prices and inflation), or excessive appreciation

(leading to higher export prices and a loss of international competitiveness) and buy time to re-evaluate economic policy. Government Policies Relating to the Exchange Rate Essentially, there are three policies that the Australian government (through the RBA) can do to try and affect the value of the exchange rate under a floating system: The RBA can intervene directly in the force market as a buyer or seller of foreign exchange. This is usually done to smooth out the market to reduce what is deemed to be excessive volatility caused by misinformed speculation. The RBA may intervene indirectly by changing the level of interest rates through its market operations. This will have the effect of altering the interest rate ?differential? between Australia and the rest of the world. A

rise in interest rates relative to overseas will encourage capital inflow and hence increase demand for the Australian dollar. This action might also be taken to prevent further depreciation of the Australian dollar. A fall in Australian interest rates will encourage capital outflow and increase the supply of Australian dollars relative to the demand. This action would prevent further appreciation of the Australian dollar. The government may use a mix of macro-economic policies to increase or decrease the rate of economic growth in Australia relative to the rest of the world. Contractionary monetary, fiscal and industrial relations policies may reduce aggregate demand, including the demand for imports, thereby raising the value of the exchange rate. Alternatively, the use of

expansionary macro-economic policy would be expected to boost aggregate demand, including the demand for imports relative to exports, raising economic growth, but lowering the exchange rate. Direct intervention Direct intervention by the RBA in the foreign exchange has potential implications for domestic liquidity. Intervention by the RBA can be ?sterilised? to offset the effects on domestic liquidity and interest rates or ?unsterilised? with intervention affecting domestic liquidity and interest rates. Sterilisation occurs when the RBA offsets its foreign exchange market intervention by buying or selling the equivalent amount of government securities, leaving the monetary liabilities of the RBA unchanged. Unsterilised foreign exchange market intervention involves no offsetting

purchase or sale of government securities. An unsterilised sale or purchase of foreign currency will lead to a fall or rise in the money supply and a rise or fall in interest rates. The RBA has always undertaken sterilised intervention. There are two means of doing this: Buying Commonwealth Government Securities in its domestic operations Arranging a foreign currency swap, by exchanging one currency for another in the current (Spot) market and agreeing to reverse the transaction at a future date at an agreed price or exchange rate (futures market) Indirect intervention Monetary policy initiatives are a more indirect way of influencing the exchange rate, and are rarely used for this purpose. If the government wishes to curb rapid depreciation, it may increase the demand for AUD by

raising interest rates. Higher interest rates will attract more foreign savings, which must be converted into AUD. This will increase demand for AUD and put upward pressure on the exchange rate, however, this policy will generally only be effective for a limited time. It is unusual for the RBA to change interest rates in response to movements in the currency because the primary focus of its monetary policy decisions is to influence the domestic economy. Sometimes the exchange rate movements are so large that they may affect the stability of the economy or the level of inflation. An example of this happening occurred in April 2000. The RBA stated that one of the factors prompting it to raise interest rates was the depreciation of the Australian dollar, which was adding to