Monetary Economics

ECON24 Monetary Economics Assignment Part 1

First quote: AUD/USD

1. Provide some facts about the FIRST currency in your chosen quote. (That is, if your quote is AUD/USD, provide some facts on the AUD. If your quote is USD/AUD, provide some facts on the USD. (about 250 words). [20 marks]
(Notes: For example, you might discuss whether the currency is fixed or floating, when this happened, how much trade is there in the currency, how this compares to others currencies and so on.)

2A. Using daily close data from the last 5 years, plot the exchange rate on a line graph, and indicate TWO specific points on the line where the trend changes. Indicate both these points with arrows on your line graph. There is an example chart at the end of this document.
NOTE: You are required to download the exchange rate data and create your own graph. It is not acceptable to copy a chart with the data from another source. [10 marks]
2B. Investigate and report the factors that may explain these movements (about 250 words per movement (total about 500 words)). [20 marks each = total 40 marks]

The remaining 10 marks will be allocated to the quality of references used and formatting. [2 marks]

IMPORTANT

1. Each of the 3 parts is separate and should be presented separately. Start each part on a new page.
2. At the end of essay, provide a bibliography for whole essay, before any tables or diagrams.
3. Pay attention to the word count. This is what you should aim for. Less than these amounts means you have not answered in enough depth.

Example chart:

Daily data past 5 years AUD/USD

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Date


SOLUTION

Question 1: First currency discussion

From the currency quote AUD/USD, my first currency is the Australian Dollar (AUD). The Australian Dollar (AUD) also known as the ‘Aussie’ is the official currency used in the Commonwealth of Australia and is regarded as one of the fifth-most-traded currencies globally by the World Foreign Exchange market. The Australian Dollar symbols are A$, AU$, and $. The AUD was first introduced in 1966 to replace the Australian pound and was valued at 0.5 against the pound. The first coins of the AUD were 50, 20,10,5,2, and 1 cent coins (Oanda, 2019). However, Australia abandoned the pound and pegged the AUD to the United States Dollar in 1967 at a value of 1 AUD = 1.12 USD

Currently, the Australian Dollar is a floating currency. This implies that the foreign exchange market sets its price based on the demand and supply comparative to currencies from other nations (Fischer, 2001). The Australian Dollar became a floating currency in 1983. This was followed by the introduction of new coins including the one-dollar coin and two-dollar coin in 1984 and 1988 respectively. The two coins were later removed from circulation in 2006. According to the World Foreign Exchange market, the Australian dollar is the fifth most traded currency globally. The preference of the AUD among currency traders is attributable to the fact that the Royal Bank of Australia usually has higher interest rates compared to other banks in the same category. The value of AUD also has a close relationship with the prices of other commodities such as the Gold spot rate. This makes it convenient for currency traders to establish their trading strategies.


Question 2: Exchange rate data presentation


Question 3: Factors Affecting Exchange Rate Trends

Differences in interest. Differentials in interest rates between the United States and Australia is one of the primary factors affecting the exchange rate trends between the AUD and USD. Interest rates and exchange rates are closely correlated. Central banks alter interest rates to exert pressure on both exchange rates and inflation, and manipulating interest rates affect the currency value. Lower interest rates provide lower returns to the local lenders in an economy compared to lenders in other countries with higher interest rates (Warnock & Warnock, 2009). Thus, lower interest rates discourage the inflow of foreign capital, causing the exchange rate to decline. Increase in interest rates, on the other hand, encourages the flow of foreign capital leading to an increase in the exchange rate. Over the past five years, the interest rates in Australia have remained relatively constant at 1.25% with relative downward manipulation expected in the current financial. On the contrary, the United States interest rate has been increasing steadily over the past five years. The interest rate in the US increased from 0.5% in 2015 to 2.25% in 2018. This continuous rise in interest rate encourages foreign capital inflow into the US economy; thus making the value of USD stronger than the Australian Doller hence the reduction in the exchange rate between the AUD and the USD. Similarly, the bank rates in Australia have remained low over the five years. This implies that the economy offered lower earnings to lenders. The reduction in foreign capital as a result of low-interest rate made the value Australian Dollar weaker every time the interest rates increased in the USA, thus the decline in the exchange rate.
Current Account Deficits. This is the second factor that affected the exchange rate movement over the period represented in the graph above. Current account deficit refers to the balance of trade between trading countries, in this case, Australia and the United States. It shows the payments between the two nations regarding interest, services, goods, and dividends. A surplus in the current account indicates that a country is earning more from foreign trade than it is spending. A deficit, on the other hand, shows that the nation is more than it receives from foreign trade. In case of a deficit, a country borrows funds to meet the shortage. An economy with a negative current account supplies more of its currency than demanded by foreigners for its products and demands more of the foreign currency that it is receiving from foreign trade — the excess demand for other currencies lovers the value of the local currency. An increase in Australian current account balance is responsible for the positive movements of exchange rates shown in the graph. For example, during the first quarter of 2019, Australia recorded a current account deficit of 2.1 billion USD. This was an increase in from 4.5 billion USD current account deficit in the previous quarter (Ceic, 2019). During this period, the AUD exchange rate against the dollar increased. The US current account balance deficit also narrowed during the same period from USD 143.9 billion to USD 130.4 billion. However, the proportion of the Australian reduction in current account deficit was greater than that of the US, leading to a stronger currency value over the period.

References
Ceic (2019). Australia Current Account Balance. Retrieved from https://www.ceicdata.com/en/indicator/australia/current-account-balance
Fischer, S. (2001). Exchange rate regimes: is the bipolar view correct? Journal of economic perspectives, 15(2), 3-24.
Oanda (2019). Australian Dollar. Retrieved from https://www1.oanda.com/currency/iso-currency-codes/AUD
Warnock, F. E., & Warnock, V. C. (2009). International capital flows and US interest rates. Journal of International Money and Finance, 28(6), 903-919.