Reserve Bank of Australia and the Impact on Australian Economy - Case Study Example

Exchange rate is one of the most influential factors which has an impact on the economic health of an economy and is one of the most important factors which have to be determined so that organization is able to grow. Exchange rate holds an important aspect in the country’s trade and is one of the most critical factors which determine the free market operation in the economy. This paper thereby evaluates the manner in which different factors have an impact on the exchange rate. This is supported by the policies developed by the Reserve Bank of Australia and comparing it to other countries so that the impact and future growth potential for the Australian economy can be ascertained. On the whole it will help to ascertain the different steps and the manner in which the economy is able to experience free exchange rates determined by the forces of demand and supply. Before moving ahead with the topic it is important to understand the manner in which exchange rate movements have an impact on the trade relationship with other nations. Economies whose currency value is high faces difficulties in exporting as export becomes expensive whereas imports becomes cheaper thereby having an impact on the balance of trade. There are different factors which have an impact on the exchange rate of an economy. Some of the factors which have an impact on the exchange rate are as Firstly, inflation has an impact on the exchange rate. A country which has a low inflation rate experiences an increase in the exchange rate primarily due to the fact that the purchasing power of the currency increases. This has an impact on the interest rate as it reduces which further impacts the exchange rate (Exchange Rate, 2013). Similarly, a country with a high inflation rate experiences a high exchange rate because the value of the currency reduces and the same currency is able to purchase few items. Thus, a change in the inflation rate has an impact on the inflation rate which the economy witnesses. Secondly, changes in the interest have an impact on the exchange rate. Interest rate, inflation and exchange rate are correlated to each other and a change in one factor has an impact on other factors thereby impacting the overall growth of the economy. The Reserve bank controls interest rate so that they are able to control the value of the currency and hence the exchange rate (Exchange Rate, 2013). A high interest rate ensures that the lenders are able to get a higher return on the lender money. This leads to increase in the foreign investment from other markets. This thereby tends to push up the exchange rate as people experience higher interest rate and profits. While, looking to make changes in the interest rate inflation has to be considered and the culmination of the different factors will determine the strategy that the Reserve bank will look to pick. Thirdly, current account deficit has an impact on the exchange rate. Current accounts highlight the balance of trade between the countries which highlights the manner in which country and its trading partners have indulged in different transactions and highlights the different payments. A deficit in the account would suggest that the economy is spending more than the economy is earning which results in the creation of deficits (Exchange Rate, 2013). To fulfill the deposit the government has to borrow money and require foreign currency to fulfill the deficit which is appearing. This thereby results in the fall in exchange rate as to attract more and more lenders the government has to provide their better return. The opposite happens in case of excess current account balance, thereby showing the manner in which the changes in current account balance has an impact on the overall growth of the economy and thereby impacting the exchange rate. Fourthly, public debt has a large impact on the overall exchange rate. The government to ensure large capital projects might borrow money from different public ventures which results in a public debt. The development of capital projects might help the government to increase their chances of growth in the future but also increases the risk of paying the debt (Exchange Rate, 2013). This at times results in selling of securities at a lower price than they actually are. The government at this juncture might look to sell the securities to foreigners and at a lower price. The foreigner with the expectation that the interest in the future will be high purchases the securities which have an impact on the exchange rate making it to be lower. The foreigners while looking to purchase the securities also look at the credit rating and the culmination of different factors determines the actual exchange rate which is present in the market. This thereby has an impact on the exchange rate and impacts the overall growth of an economy. Fifthly, the terms of trade also determines the exchange between countries. Countries whose export grows by an increased percentage as compared to the import witnessed an increase in demand for the countries product which thereby translates into increased demand for the currency (Exchange Rate, 2013). This thereby pushes the exchange rate as the growth in the demand for currency increases its value which leads towards an increase in the overall exchange rate. The opposite happens in case the export falls and import increases thereby leading to a change in the exchange rate. Sixthly, political stability and economic performance determines the exchange rate between countries. An economy which is politically stable and is witnessing a high growth rate will tend to attract investors from all direction. This will tend to increase the demand for the local currency making the currency to be expensive (Exchange Rate, 2013). This would mean that the purchasing power of currency has increased which would thereby attract more and more investors further leading towards an increase in the exchange rate. The opposite happens in case the economy is experiencing difficulties both on the political and economic front. Thus, there are many factors which has an impact on the exchange rate and the government of all the economies needs to evaluate the different factors and based on it develop strategies so that the exchange rate improves and the economy is able to project a better opportunity of growth. The Reserve Bank of Australia in comparison to other countries has looked towards taking the following steps which will ensure stability in exchange rate and provide an opportunity for the economy to grow at a rapid pace (Debelle, 2012). The Reserve Bank of Australia after looking and analyzing the different factors which the economic scenario presents has determined the different steps it will adopt. It is clearly evident that the Reserve Bank of Australia has kept the interest rate unchanged at 2.75% highlighting that the last quarter has been one where the Reserve Bank of Australia has been able to control inflation. This has resulted in gaining stability in the foreign exchange market and has ensured that the government has proper holding of different foreign currencies. The Reserve Bank of Australia has been able to control inflation and keep it at affordable an rate which has thereby ensured that the Aussie Dollar is trading at 0.90 of Greenback highlighting effective policies taken by Reserve Bank of Australia. This has reduced the currency risk and has developed the required market where the demand for different products and services are increasing. This has resulted in the Australian Securities Exchange (ASX) 200 to attract foreign investment which has thereby ensured proper and stable exchange rate (Debelle, 2013). The Reserve Bank of Australia have used loose monetary policies where they look at absorbing the excess liquidity within the market which has helped to keep inflation in check and provided sufficient cash balances to meet the different expenses. The policies of the Reserve Bank of Australia has helped to ensure a foreign deposit of $36 billion out of which 45 percent is in US dollar, 45 percent is in EURO and the rest is help between Yen and Canadian Dollar (Vallence, 2012). The strategies adopted by the Reserve Bank of Australia have helped to ensure cash liquidity and has developed the overall framework through which the economy is able to find out the different variables which will contribute towards stability in the exchange rate. The monetary and fiscal policies are directed towards expansion and the control exercised on inflation and interest rate by the Reserve Bank of Australia has helped to ensure that the overall money supply is controlled. This has ensured stable exchange rate and provided an opportunity where the Australian economy can project better growth rates and increase their chances of exhibiting better growth rates (Lowe, 2012). Thus, the paper highlights the manner in which different factors have an impact on the exchange rate and the steps the government and the Reserve Bank needs to take to control it. It also highlights the manner in which different fundamentals and dynamics needs to be emphasized as shown by the Reserve Bank of Australia which has helped to develop policies which ensures stable exchange rate. The overall steps needs to be directed and controlled in a manner which will highlight effectiveness and provide an opportunity of growth in the future. References Debelle, G. (2013). The Reserve Bank’s Operation in Financial Market. Retrieved on August 5, 2013 from http://www.rba.gov.au/speeches/2013/sp-ag-260213.html Debelle, G. (2012). Regulatory Reforms and their Implications for Financial Markets, Funding Costs and Monetary Policy. Address to the Financial Services Institute of Australia, Adelaide, 18 September Exchange Rate. (2013). Factors that Influence Exchange Rate. Retrieved on August 5, 2013 from http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing.html Lowe, P. (2012). What is Normal? Address to the Australian Business Economists Annual Dinner, Sydney, 5 December Vallence, C. (2012). Foreign Exchange Reserves and the Reserve Bank's Balance Sheet. RBA Bulletin, December, 57–63 Read More