Exchange Rate Influence, Strategies Used by the Reserve Bank of Australia - Case Study Example

Exchange Rate Influence . Student’s Name: Tutor’s Name Date: The paper aims at presenting factors affecting currency exchange rate. The exchange rate is value given to a certain currency against that of another country. These factors are mainly dependant on the demand and supply of the foreign currency. The paper also presents strategies used by the reserve bank of Australia to ensure that all is well in the currency market. Strength of the Economy This is measured in terms of how fast the economy is growing. The fast growing economies will attract a lot of trade that comes with the foreign currency. The countries that highly import have low foreign currency because the country has to pay for these imports. There are countries which are net exporters and they gain a lot of foreign currency compared to the one they spend. The reason behind this is that the strength of the country’s economy affects the supply and demand of forex. The countries that gain a lot of foreign currency tend to stabilize their local currencies because they spend less. Political and Psychological Factors These are the factors that relate to having a stable environment in the country. This stability mainly comes from the political arena. The major currencies tend to fluctuate when there is instability in the country. The change of government is another factor that affects the foreign currency in or out of the country. This is related to the normal trends of the world economy where a slight change in the political instability of country that tend to affect the local currencies making it hard for such currencies to attract exchange from other countries. The political instability mainly caused by wars makes it hard for a country to participate in the exchange of currency. Inflation Rates There is an allowance given by monetary authorities to cater for inflation level in the country. It is given in that when the level of inflation increases the exchange rates have to compensate for the loss realized from the inflation levels. It is also designed in a way to allow for deprecation of the exchange rates if they are overvalued. The reason behind this is that the monetary authorities work to reduce the inflation because it reduces a country’s competitiveness and makes it hard for such a country to operate in the international market. The reason behind this is that inflation tends to weaken the domestic currency and makes it lose it demand as a foreign currency. This means that there is an influx in the domestic currency and a shortage in foreign currency. Capital Movements Foreign investment in a country comes in inform of foreign currency. This foreign currency is invested by buying equity shares in the country of investment. For example, during liberalisation in many countries there was a lot of foreign currency coming into the liberalising countries. This help in strengthening the local currencies. The reason behind this is that the local currencies are converted into the foreign currencies so as to help the investors to invest in the local market. This also has negative impact on the local economy in case there is capital flight because this weakens the domestic economy. The reason behind this is that the domestic currency will have to be exchanged so as to enable the country participate in the international market. The only currencies that are not affected are the ones that cannot be converted in the capital account. Speculation Speculation is a situation where there is an expected rise or fall in the values of a certain currency. For example, in a country where there is a shallow foreign exchange market purchase of high amounts of a foreign currency will lead to an increase in the value of that foreign currency. This will weaken the domestic currency against such foreign currency. Right speculations increase ones value in the currency but speculation can also lead to a loss. Speculation is just as a prediction that a certain foreign currency will take a certain direction and what will be the results. Balance of Payments The balance of payment is the difference between the value of a country exports and the value of what the country imports. Increased inflow of foreign currency in a country helps in strengthening a country’s domestic currency. The more the country is selling products to other countries the more it gains foreign currency and the country spending is limited on the products it is buying from other countries makes it in excess demand. This means that the balance of payment is positive and the country’s currency is stable. The countries with very strong currencies have little to spend on buying products from other counties. Government’s Monetary and Fiscal Policies These policies affect country’s involvement in the international trade because they work to ensure that there is a trade of balance. Therefore, the regulatory authorities work to control the supply and demand of a currency. The increased of a foreign currency in a country means that there is a lot to be spent and this increases prices thus making imports very attractive. The regulatory authorities ensure that there are no fiscal surpluses because they slow economic growth in a country because this increases demand for exports and reducing that of the imports. The monetary and fiscal policies ensure that there is currency check so as to ensure that inflation in the country is reduced. Exchange Rate Policy and Intervention The government make interventions so as to control the supply and demand of currency in the country. This is mainly taken by the central banks in many of the countries so as to stabilize the currency market. The central bank takes an initiative to buy currency so as to reduce its flow in the hands of the public. The central bank can also take the role of selling the currency so as to increase its flow in the market. This affects the exchange rates in that the law of demand and supply applies. The increase in supply of foreign currency means that the exchange rate is low because the demand is low. The demand increases when there is limited supply of the foreign currency and this means that the exchange rate is high. The government and the central bank should ensure that there interventions are well planned for so as to ensure that they does not cause a sudden change in the market. Interest Rates Interest rates are different in many countries and this affects the major world currencies. This makes it possible to adjust the exchange rate so as to cater for the differences in the interest rates in different countries. High interests rates in the country do not attract genuine investors but attracts speculate investors who intend to gain from buying of bills and bonds sold by the government. The weaker economies tend to set low rates so as to attract investors. Therefore, interest rates highly affect the exchange rates because they have to cater for different rates given in the countries. Strategies used by the reserve bank of Australia Monetary policy The reserve bank passes policies that ensure the country does not experience deficits in the foreign currency reserves. The monetary policies can be aimed at reducing the interest rates or increasing them. The bank regulates the flow of the foreign currency to ensure the country’s economy is stable. This will help the bank to control the currency that is in the hands of the general public so as to avoid inflation and the surplus in the country. This would destabilize the economy and make the local currency unattractive for exchange in the world market. Taxation Taxation refers to an assessment by the government of property value, estates and transactions of a deceased person, licenses granting income or a right, as well as import duties from all foreign countries. Taxation covers and includes all what a government imposes upon an individual, and this is aimed at serving or for service of the state. Taxes are divided into two classes: indirect taxes and direct taxes. Laws and policies that direct the process of tax, together with rules, are covered by the tax law. These factors of the tax process involve charges on transactions, estates, income, property, licenses and more, by the government. The tax law and taxation includes also duties on imports from all foreign countries, as well as all levies which are compulsory and imposed by the government on individuals, and this is done for the advantage of the state. Conclusion In conclusion, the country has to observe and control the exchange rate so as to ensure that the domestic currency does not lose value against the other currencies. The above factors that affect the exchange rate need to be put on check by the reserve bank of Australia. The Reserve bank of Australia uses the above strategies to control this market. References Reserve Bank of Australia (1999): Annual Report Sarno, L and M P Taylor (2001): “Official intervention in the foreign exchange market: is it effective, and if so, how does it work?”, Journal of Economic Literature, vol 39(3), pp 839-68. Scalia, A (2004): Is foreign exchange intervention effective? Some micro-analytical evidence from central Europe, mimeo. Tapia, M and A Tokman (2004): “Effects of foreign exchange intervention under public information: the Chilean case”, Economia, LACEA, vol 4, Spring, pp 1-42. Taylor, M P and H Allen (1992): “The use of technical analysis in the foreign market”, Journal of International Money and Finance, 11(3), June, pp 304-14. Truman, E M (2003): “The limits of exchange market intervention”, in C F Bergsten and J Williamson (eds), Dollar overvaluation and the world economy, Institute for International Economics, pp 247-65. Woo, W T (1987): “Some evidence of speculative bubbles in the foreign exchange markets”, Journal of Money, Credit and Banking, vol 19, no 4. Read More