Negative and Positive Impacts on the Australian Economy - Assignment Example

Assignment 1 (Four Questions) Student’s name Course Tutor’s name Name of institution Location of institution Date a) A brief summary of issues discussed by Collett (2014) The article by collect (2014) describes the question in most Australians’ minds. The article creates an impression that Australians (especially those interested in foreign travel), do not know whether to exchange their Australian dollars or hold on with the hope that their domestic currency will stabilise against other major currencies. The articles goes ahead to explain the departure from the norm where most foreign exchange conversions are conducted right before the holiday seasons in June and December. In an attempt to lock the value of the Australian dollars, Collett (2014) explains how Australians are rushing to purchase foreign currency, and using travel cards to ensure that they do not lose their money’s worth. The article further indicates how travel cards serve the convenience of their users by accommodating up to 10 different currencies, and how such cards provide a convenient way for Australian users to lock the exchange rates. Collett (2014) also notes that the cards’ costs vary. The travel cards are different from credit cards in that the latter apply the prevailing exchange rates at the time of the transaction. Collett (2014) also observes that analysts did not (at the time of writing the article) expect the Australian dollar to recoup its losses against the US dollar and the sterling pound. The analysts’ opinions were based on the relative interest rates in Australia. The article creates the impression that Australian interest rates were lower than those of other (comparable) countries, hence the weakening Australian dollar. The article relies on inputs from analysts such as AMP Capital Investors’ chief economist, Dr. Shane Oliver. In the article, Oliver offers several projections including the possibility that the Australian dollar would exchange at US$ 0.88 for the remaining part of 2014. He however predicted that the rates would fall by mid-2015. Oliver further held the opinion that the Australian dollar would hold steady against the sterling pound. Overall, the article provides a general overview of how travellers are reacting to a fluctuating Australian dollar. One gets the impression that consumers are out to secure their money’s value, most especially those who are interested in foreign travel. The article also gives a general overview of what to expect from the exchange rate market, forecasting (through Shane Oliver) that not much fluctuation would be observed for the remaining part of 2014. The analyst however indicates that significant changes would most likely be observed in mid-2015. The article is more of a report than an analysis, and as such, one gets an idea of how consumers react when they are not certain of what to expect in the foreign exchange market. b) Over the past three years (12 quarters or 36 months), which way has the Australian dollar moved relative to that of the US dollar? The Australian dollar has been on a downward trend relative to the American dollar. In data gathered from X-Rates (2015), it is evident that in the 36 months lasting from April 2012 to March 2015, the highest the Australian dollar has ever traded against the US$ is 1.04. These exchange rates were between December 2012 and January 2013 (see figure 1). Currently, the A$-US$ exchange rate is at 0.77. Figure 1: The A$-US$ exchange rate between April 2012 and January 2015 Source: X-rates (2015) Garrett (2013) has offered several plausible reasons for the falling exchange rate of the Australian dollar. One of the reasons is that unlike during the economic crises when a more expensive Australian dollar gave people the incentive to convert their money into the currency, the stabilising of the US$ has made the latter currency more appealing to money owners. Another plausible reason is that the Australian economy is now slower than it was three or four years ago, and this means that interest rates are now lower (Garrett 2013). Lower interest rates imply that people who invest in the money markets do not get as much returns as they used to when the economy was moving fast. Additionally, Garrett (2013) notes that the interest rate differentials that existed between the US and Australia are decreasing, hence meaning that people who had invested in Australia for purposes of harnessing the benefits associated with high interest rates can do the same in the US. Consequently, the foregoing scenario has put more downward pressure on the Australian dollar. Garrett (2013) further indicates that lower prices of natural gas, coal and iron ore have all contributed to a weaker Australian dollar. The lower price for the three aforementioned commodities is occasioned by price shifts in the global market. Increased supply in the global market means that Australia has to export and sell its products at prevailing market rates. The low commodity prices have drastically affected the value of the Australian dollar negatively. The fourth reason cited by Garrett (2013) is the slowing down of the Chinese economy. In the last decade, Australia has fuelled China’s economy through the provision of resources such as iron ore and coal. Since the Chinese economy is not as active as it was a decade ago, the demand for Australian inputs has declined drastically. A decline in exports naturally depresses the value of the Australian dollar. c) Explain how a weak exchange rate for the Australian dollar could have both negative and positive impacts on the Australian economy One of the negative effects of a weak Australian dollar is an increase in the interest payable on foreign debts. Higher interest rates on the foreign debts translate into wider income deficits, which will lead to an increased foreign debt. Notably, when the exchange rate weakens, Australia commits more Australian dollars in repaying its foreign debts since all its debts are usually in foreign currency (usually the US$). Another negative impact of a falling Australian dollar is related to inflation. Usually, when the Australian dollar is weaker compared to other major currencies (for example, the US$), imports to Australia are more expensive. The implications of higher costs of imported goods are felt in the local market where people spend more money to purchase specific products. In the end, the high consumer prices lead to a higher cost of living, which is ideally what is termed as inflation (especially if specific consumer goods are affected by price hikes). Woodington (2013) also notes that the cost of foreign travel will rise and this will drastically reduce the flexibility of Australian tourists as the high costs will limit their choices for international travel. The positive effects of a weak exchange rate for the Australian dollar include the fact that imports attract more costs and as such, people in Australia prefer purchasing locally made products. When this happens, the local manufacturers create room for more people hence leading to employment creation. Additionally, a cheaper Australian dollar leads to increased exports, which in turn creates room for more employment creation in the country. Employment creates increased revenue channels for Australians, meaning that their purchasing power increases and this, combined with increased manufacturing activities, lead to higher economic growth rates (Woodington 2013). Another possible positive impacts arising from a cheaper Australian dollar is that the country will become more appealing to investors from elsewhere in the country. As a result therefore, Australia is likely to witness an influx of foreign investors into the country. Moreover, the tourism sector may benefit from both the foreign tourists who will find Australia to be a cheaper tourism destination, and from local tourists who will find foreign tours more expensive. Instead of spending more on foreign tours therefore, it is most likely that local tourists will opt to spend their vacations within the country. Woodington (2013) notes that studying in Australia will also become cheaper compared to other foreign destinations, and as such, more international students may consider Australia as their foreign education destination of choice. d) What action could the Reserve Bank can take in order to restore the exchange rate, and what side effects might these actions have? Do you think that such actions would be effective? According to Stevens and Jericho (2014), the Reserve Bank of Australia (RBA) can increase the interest rates in order to increase the exchange rates. Arguably, if Australia offers a higher rate of returns in comparison to other countries (especially in the developed world), investors would jump at the opportunity of cashing in on the dollar, and consequently, the Australian dollar would be in higher demand and its value would appreciate. However, a forced appreciation of the dollar, would undo some of the advantages that a lower dollar has. For example, it would become more expensive to invest in, tour or even study in Australia. Additionally, imports would become cheaper, making Australian-made products to face stiff competition in the home market. Consequently, layoffs would happen, something that would probably lead to increased unemployment in Australia. According to the RBA (2015), the RBA can also create a temporary demand for the Australian dollar by buying the domestic currency against another dominant currency (for example the US$). By buying Australian dollar, the RBA creates the impression that the currency is in high demand, and this could occasion an appreciation of the Australian dollar. Notably, the RBA trades with its own name (RBA) in the world markets and as such, most analysts would be aware that RBA is responsible for the increased demand for the Australian dollar (RBA 2015). Arguably, the chances of RBA engaging in cosmetic demand creation for the Australian dollar are slim, because according to RBA (2015), the bank can only intervene in the exchange rate if the welfare of Australians is at stake. Additionally, RBA (2015) indicates that it can interfere with the free floating exchange rate regime if the employment situation in the country is at risk. The third and final condition for interference in exchange rates by RBA (2015) is if the stability of the domestic currency is at risk. RBA (2015) however admits that the effects of RBA creating a temporary demand for the Australian dollar are not well known because there is no sufficient data to prove its efficacy or the lack thereof. Since Australia has already adopted a floating exchange rate regime, this paper highly doubts the efficacy of RBA interventions in an attempt to increase the Australian dollar’s value. As RBA (2015) indicates above, there is no evidence that its intervention can enhance the Australian dollar’s worth. Consequently, it is most likely that market forces will direct future exchange rate trends for the Australian dollar. References Collett, J 2014, ‘Travellers rush to exchange their Australian currency’, The Age-Money, 2 November, viewed 14 March 2015, . Garrett, G 2013, ‘Reasons why we should expect a lower Australian dollar’, The Conversation, 21 June, viewed 14 March 2015, . Reserve Bank of Australia (RBA) 2015, ‘The exchange rate and the reserve bank’s role in the foreign exchange market’, viewed 14 March 2015, . Stevens, G & Jericho, G 2014, ‘Stimulating Australia: why lower interest rates may not be the answer’, The Guardian, 21 August, viewed 14 March 2015, . Woodington, M 2013, ‘Pros and cons of a falling Australian dollar’, Commonwealth Bank, 26 June, viewed 14 March 2015, . X-Rates 2015, ‘US Dollar per 1.00 Australian Dollar monthly average’, viewed 14 March 2015, . Read More