The Australian dollar is currently very high, with a value of US$0.80. Many people expect the Australian dollar to rise even higher by the end of the year, to as much as US$0.90.
Use a ¡°FOREX¡± (foreign exchange market) diagram to show the impact of this expectation on the Australian dollar. In your answer you must explain the effect of this expectation on the money supply (MS), the holdings of the Reserve Bank of Australia (the Central Bank) of gold and foreign exchange, the Current Account and
Capital Account balances, and on Australia¡¯s overall Balance of Payments. For convenience you can assume that the current account is in deficit and the capital account is in surplus.
Do some research, then take a shot. What do you think?
Given the information provided, an increase in the expectation of the value of the Australian dollar (AUD) is likely to have several impacts on the various components of the economy. Let's analyze these impacts step-by-step.
1. Money Supply (MS): Expectation of a higher AUD value attracts foreign investors. To meet this increased demand, investors will need to exchange their foreign currency for AUD. This will lead to an increase in the money supply in the country.
2. Holdings of the Reserve Bank of Australia (RBA): As foreign investors exchange their currency for AUD, the RBA will experience increased reserves of foreign exchange. These reserves can include currencies like the US dollar (USD) among others.
3. Current Account Balance: The current account represents the balance of trade in goods and services, income, and transfers. Given that the current account is assumed to be in deficit, an increase in the AUD value would make imports relatively cheaper and exports relatively more expensive. This could lead to a deterioration of the current account balance, as imports increase and exports decrease.
4. Capital Account Balance: The capital account records the flow of capital in and out of a country. Assuming a surplus in the capital account, an increase in the AUD value would likely attract more foreign investment. This influx of capital would contribute to a surplus in the capital account balance.
5. Overall Balance of Payments: The balance of payments is a record of all financial transactions between a country and the rest of the world over a specific period. Given the impact on the current account and capital account as discussed above, an expected increase in the AUD value could result in a larger overall deficit in the balance of payments.
As for the diagram, a FOREX diagram typically depicts the relationship between the exchange rate and the demand and supply of foreign currency. It includes the X-axis representing the quantity of foreign currency and the Y-axis representing the exchange rate. Using a graphical representation, it should show an increase in demand for AUD due to the expectation of value increase.
Keep in mind that the actual effects on the economy may vary depending on various factors such as interest rates, economic growth, and government policies. It is always advisable to consult further research and expert analysis for a comprehensive understanding.
To illustrate the impact of the expectation of a higher Australian dollar on various factors, we can analyze the scenario with the help of a foreign exchange market diagram.
1. Money Supply (MS): Expectations of a higher Australian dollar can influence the money supply. If people believe that the Australian dollar will appreciate, there might be an increased demand for the currency. This increased demand can lead to an influx of foreign currency into the Australian economy, resulting in an expansion of the money supply.
2. Holdings of the Reserve Bank of Australia (RBA): If the expectation of a higher Australian dollar is widespread, the RBA might experience an increase in its holdings of foreign exchange. The RBA can accumulate foreign currencies if individuals and businesses are exchanging their currency for Australian dollars due to the expected appreciation. However, it's important to note that the RBA can also adjust its holdings of foreign exchange through open market operations or intervention to manage the currency's value.
3. Current Account and Capital Account balances: Assume the current account is in deficit and the capital account is in surplus. An expectation of a higher Australian dollar can potentially impact the balances of these accounts. As the Australian dollar appreciates, it becomes more expensive for foreign buyers to purchase Australian goods and services. This can cause a decrease in the exports of Australia, resulting in a larger current account deficit. On the other hand, a higher currency value can encourage capital inflows into the economy, increasing the surplus in the capital account.
4. Australia's Balance of Payments: The balance of payments is a record of all economic transactions between Australia and the rest of the world. The expectation of a higher Australian dollar can influence the balance of payments. If the current account deficit expands due to decreased exports, it could contribute to a deterioration in Australia's overall balance of payments. However, the capital account surplus resulting from increased capital inflows could mitigate the impact to some extent.
Please note that this explanation is a generalized analysis based on the given scenario. The actual impact on these variables may depend on various factors such as market sentiment, economic conditions, and government policies.