What is the current exchange rates and the Australian economy

What is the current exchange rates and the Australian economy
Photo: Robyn Mackenzie, BS

Just like other economies in the world, the Australian economy is affected by the exchange rate. The exchange rate of the Australian dollar in relation to other currencies in the world can affect the economy either directly or indirectly. In direct terms, the exchange rate determines the value of the goods and services produced locally relative to those that are produced in outside markets.

In indirect terms, the exchange rate has an effect on economic factors that might influence the policy on local production. In overall, the exchange rate has a huge effect on the balance of payments.

At any given time, the Australian dollar is valued at a particular price. If the price of the Australian currency gains over another currency in relative terms, then the Australian dollar is said to have appreciated.

If the opposite is true, then the currency is said to have depreciated. The exchange rates are thus fundamental when trying to understand the economy.

The direct effects of exchange rates

Exchange rates affect the prices of goods locally. The depreciation of the Australian dollar will be followed by a change in the price of locally produced goods. In effect, when the Australian dollar loses value, then the goods produced locally will have a lower price when compared to those that are produced in overseas markets. Visitors to Australia will be able to exchange fewer units of their currency to get the Australian dollar.

People holding foreign currencies will also pay less for services in Australia. If the Australian dollar strengthens, however, Australians will find it much easier to pay for services while in foreign countries. The demand for local currency at the forex market will also be affected by a change in the value of the Australian dollar.

The indirect effects of exchange rates

Just like with the direct effects of exchange rates, the indirect effects of exchange rates are closely tied to the prices of goods. Inflation has a close relationship with the changes in exchange rates. The indirect effects of exchange rates on the Australian economy will be highlighted by:

  • The labor market and the general economy
  • Interest rates and inflation

Effects on the labour market

To start with, a devaluation of the Australian dollar will lead to the increase in demand for Australian goods. This is because the goods will appear to be cheaper for overseas consumers. There will be increased competitiveness for locally produced goods and the market export will become more attractive.

The level of imports will also reduce as Australian consumers will find goods produced overseas to be more expensive. The local import market will thus shift their attention to locally produced alternatives.

The effects of these changes will be felt in the labor market where the demand for more workers will be apparent. Less demand for overseas goods will create the need for vibrant local industries. Skilled manpower will, in turn, be needed in these industries and this will drive up the employment levels.

The labor market will thus become attractive. An appreciation of the Australian dollar will cause the opposite of this to happen.

Effects on interest rates and inflation

A depreciation of the Australian dollar will result in higher priced overseas goods. This will lead to inflation. Other than that, the increased local demand and employment levels will also ultimately lead to inflation. Excessive inflation might call for a monetary policy change. Since it takes time for these effects to occur in a typical economy though, the adjustment might not be quick.

Firms that sell goods first have to run out of stock before they reconsider their prices. Consumers also take time before they change their habits and so on. The effects thus take a few years to be fully evident.

The balance of payments

Finally, the effects of exchange rates are most important when it comes to the balance of payments. The overall value of goods will change when the exchange rates change. If the currency has depreciated, for instance, the short-term direct effect on the balance of payments will a widened account deficit as a result of decreased net exports.

On the contrary, the indirect effects will diminish the account deficit in the short-term. The long-term effects are, however, the opposite. In general, the changes in the exchange rate will not only affect the consumer market but also the current account and the liabilities of the country to foreign governments.