The High Australian Dollar - Term Paper Example

Running Header: The High Australian Dollar Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission: Contents 1 2 Contents 2 2 1.0 Abstract 3 2.0 Introduction 4 3.0 Background of the Study 5 3.1 Inflation 5 3.2 Economic Growth 5 3.2 Unemployment 5 4.0 Expansionary Monetary Policy 6 5.0 Arguments for the Expansionary Monetary Policy 8 6.0 Arguments against Expansionary Monetary Policy 9 7.0 Summary and Conclusion 9 References 10 1.0 Abstract The current appreciation in the Australian dollar has attracted concern from economists due to the challenge that it exposes to the economy of the country. Moreover, concern with the high Australian dollar has aroused from exporters due to the high prices of their products leading to a reduction in Australian exporters. That is why a study relating to the high Australian dollar is of vital of importance. This term paper tries to explore and understand the effects caused by the high Australian dollar. The paper also comes up with a macro-economic policy that can be used to solve this problem. The paper finds that the high Australian dollar has led to a reduction in the country exports and an increase in imports hence affecting the country’s balance of pay. However, through the use of expansionary monetary policy the Australian government can solve this problem. 2.0 Introduction The Australian dollar has experienced appreciation over the last few years and this has increased its strength and value as compared to other currencies around the world. Carvalho, Eusepi and Grisse (2012, p. 3) note that the strong appreciation of the Australian dollar has led to high exchange rates and this has raised increasing concerns over its impact on the trade exposed sectors of the economy. The rise in the value of the Australian dollar can be attributed to the large scale mining activities as well as the high production of primary products in the country. Moreover, the high export prices of commodities produced in Australia forced the foreign countries to increase their demand for the Australian dollar and this made its exchange rate to appreciate. However, the high value of the Australian has both positive and negative impacts on the economy of the country. According to the manufacturing industry consortium paper (2011, p. 11) the high Australian dollar presents challenges to the high value manufacturing industry hence the need for them to come up with strategies for solving this challenge. The high Australian dollar makes the country’s exports to be more expensive as compared to products exported by other countries and this makes the Australian products to be less competitive. The high exchange rate as a result of the high Australian dollar has created negative impact on trade and this has affected the volume and values of the country exports (Lim 2011, p. 8). Therefore, it is evident that the high Australian dollar poses a major challenge to the economy of the country. The purpose of this term paper is to identify and analyze a macroeconomic policy that can be used to control the high Australian dollar. 3.0 Background of the Study 3.1 Inflation According to Boyes and Melvin (2012, p. 320) a country’s exchange rates can determine the ability of the government to achieve its policy objectives and goals. The high exchange rates can act as a means of moderating Australia’s inflation rates. High exchange rates cause the prices of imports to decline and these forces other importers to cut their foreign currency prices in order for them to remain competitive. The high exchange rate also leads to a reduction in the aggregate demand and this causes imports to increase and exports to decline hence causing inflation to fall. The fall in aggregate demand depends on the price elasticity of demand for imports and exports. This means that higher the price elasticity, the greater the change in export and import volumes and this is brought about by the movements in the exchange rate. 3.2 Economic Growth Aderton (2008, p. 260) states that high exchange rates can have long term negative effects on the economic growth of a country. This is because of the fact that high exchange rates discourage exports and encourage imports and this leads to a reduction in domestic investment. Moreover, high exchange rates cause a reduction in the aggregate demand and thus a reduction in the equilibrium output. The low output can make Australia to experience low economic growth. 3.2 Unemployment Additionally, the high exchange rates can make Australia to experience an increase in the levels of unemployment. Higher exchange rates lower aggregate demand and this causes a reduction in output hence unemployment. Unemployment as a result of high exchange rates can be mostly experienced in export related industries. Nevertheless, the high exchange rates in the country can deteriorate the balance of payment. This is due to the increase in imports and a reduction in exports. On the other hand, the Australian population will demand more imports due to their low prices and this will create an imbalance of in trade (Brigham and Daves 2009, p. 952). 4.0 Expansionary Monetary Policy The Australian government can control the high Australian dollar through expansionary monetary policy. According to Kroon (2007, p. 202) in the expansionary monitory policy the government increases the amount of money supply in the economy. This in turn reduces the exchangerates and increases the prices of bonds. The low exchangerates cause an increase in capital investment and at the same time it makes a country’s bonds to be less attractive. This causes the demand for foreign bonds to increase while the demand for domestic bond declines. Consequently, the demand for the domestic currency declines whereas the demand for foreign currency increases and this causes a decrease in the exchange rates. The low exchange rate will enable Australia to increase its exports and decreases the amounts of imports hence create a balance of trade. The expansionary monetary policy will enable the Australian firms to increase their exports by reducing the price of their inputs hence making them to be more competitive in the global markets. Furthermore, the expansionary monetary policy will enable the Australian households to have more money to spend hence this will motivate them to increase their consumption. This will make the industries to increase their output. Moreover, the expansionary policy will make it possible for the Australian households to increase their investments and this will promote economic growth in the country. On the other hand, the policy will assist the government to reduce the high exchange rate and at the same time assist in reducing the high Australian dollar. Additionally, the policy will enable the government to increase the employment levels in the country, encourage investment and improve the balance of trade. A Graph Showing Expansionary Monetary Policy Source: Arnold (2010, p. 325). Increase in money supply by the government will shift the demand curve for money from D1 to D2. This will in turn lead to a reduction in the exchangerates from Ia to Ib. The decline in exchangerates will make the Australian bonds to be less attractive hence this will cause an increase in the demand of foreign bonds. As a result, the demand for foreign cash will increase and this will reduce the high Australian dollar and cause a reduction in the exchange rates. The rationale behind the expansionary monetary policy is that it leads to an increase in exports and this increases the economic growth of the country. Moreover, the expansionary policy increases the aggregate demand and this will be important in escalating the level of employment in the Country. This is because the increased demand will make Australian firms to hire more workers so as to enable them to increase their output with an aim of meeting the increased demand. Furthermore, adoption of the expansionary monetary policy in the country will encourage investment in capital assets and this can assist in facilitating the economic growth in the country. According to Carvalho, Stephano and Grisse(2010, p. 3) the expansionary monetary policy contains an immediate effect on the economy. This means that the results associated with the implementation of the policy are felt immediately in the economy. However, this policy requires the government to spend a lot of funds in order to increase the amount of money in the economy hence this may prove to be an expensive exercise. 5.0 Arguments for the Expansionary Monetary Policy Duffy (2003, p. 78) notes that the expansionary monetary policy is favored because of the fact that it leads to an increase in a country’s GDP. The expansionary monetary policy causes exchange rates to fall and this increases aggregate expenditure on investments and expenditures hence these causes the GDP to increase. Therefore, the expansionary monetary policy can make Australia to increase its GDP and this can facilitate the country economic growth. 6.0 Arguments against Expansionary Monetary Policy Monetarists argue that the expansionary monetary policy has only a short run effect on the economy (Duffy 2003, p. 81). This means that by adopting the policy the Australian economy will experience increased GDP in the short run while in the long run the policy may make the country to experience inflation. In the long run the Australian economy will operate at full employment and thus the expansionary policy will only act as a link between the price level, the supply of money and the real GDP. Therefore, the expansionary policy may only lead to inflation hence it may not affect the level of GDP in the country. 7.0 Summary and Conclusion In conclusion, the high Australian dollar has led to an increase in the country exchange rates and this has led to a reduction in exports and an increase in imports. The high exchange rates have made the country’s exports to be very expensive and thus they have been less competitive in the international markets. However, the government of Australia can adopt expansionary monetary policy in order to reduce the exchange rates. The expansionary monetary can assist the government to increase employment, investment, aggregate demand and promote exports. The expansionary monetary policy can lead to an increase in Australia’s GDP though the monetarist argue that in the long run the policy can lead to inflation. References Anderton, A 2008, Economics, Dorling Kindersley, New-Delhi. Arnold, R 2010, Economics , Cengage Learning, Mason. Boyes, W & Melvin, M 2012, Macroeconomics, Cengage Learning, Mason. Brigham, E & Houston, J 2009, Microeconomics, South- Western Cengage Learning, Mason. Carvalho, C, Eusepi, S & Grisse, C 2012, ‘Policy Initiatives in Global Recession’, Current Issues in Economics and Finance, vol. 18, no. 2, pp. 1-11. Duffy, J 2003, Macroeconomics, John Wiley & Sons, Oxonn. Industry Consultation Paper 2011, ‘High-ValueManufacturing –Its Time to Talk’, In high – Value Manufascturing, pp. 1-13. Kroon, G 2007, Macro-Economics the Easy Way, Barron’s Educational Series, New York. Lim, S 2011 ,‘The Impact of the Appreciating Exchange Rate on Trade Exposed Industries’, In Economics Research Note, pp. 1-9. Read More