ECON910: AUD Depreciation, Global Economic Factors, and Policy Impact

This assignment analyzes the depreciation of the Australian dollar (AUD) against the US dollar (USD), focusing on factors such as global economic slowdown, declining commodity prices, and the Reserve Bank of Australia's (RBA) monetary policy. The analysis examines the impact of these factors using demand-supply dynamics and graphical representations of exchange rate trends. It further explores the effects of AUD depreciation on Australian software exporters, providing a numerical example to illustrate revenue implications. The assignment also discusses the potential impact of the RBA's actions to influence the exchange rate, including interest rate adjustments, and their broader consequences on the domestic economy. The analysis considers the balance between the benefits of depreciation, such as increased export competitiveness, and potential drawbacks, such as inflation and reduced consumer spending. The assignment draws on economic theories and real-world data to provide a comprehensive overview of the topic.

ECONOMICS FOR PROFESSIONALS
ECON910
STUDENT ID:
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(a)The main issue highlighted in the selected article is the depreciation in AUD which has
touched a 10 year low against the USD. The article aims to indicate key factors that can
potentially account for this fall in AUD. One of these is the tepid growth in Europe
particularly Spain, Italy and Germany. Besides, the manufacturing PMI data globally has
been falling and has touched the lowest level which indicate concerns of global growth. In
this backdrop, there has been an increase in the USD demand as investors are buying US
treasury bonds to keep their money safe. Additionally, China is also experiencing a
slowdown which has had adverse price impact on key commodities. This is likely to be
detrimental for the Australian economy considering the mining based exports from
Australia. Also, it was expected that RBA (Reserve Bank of Australia) would increase the
interest rate but on account of global slowdown and slower than expected recovery of
Australian economy, the rate increase might be deferred. These three factors are leading to
depreciation of AUD against the USD (Moore, 2019).
The impact of the above factors on the exchange rate is derived through the demand supply
mechanism. As for commodities, the equilibrium exchange rate is determined by the
corresponding demand and supply of respective currency in the market. Hence, any change
which would result in higher demand of a respective currency against the other would lead to
appreciation of the currency (Barro, 2017). On the contrary, any increase in supply for a
given currency would lead to falling market value or depreciation of currency. A
demonstration of the demand supply dynamics in the scenario presented can provide an
explanation for USD appreciation. This is because globally there is a trend of increasing fund
flow into US treasury bonds leading to higher demand of USD and appreciation of same
(Dombusch, Fischer and Startz, 2016).
(b) Using the historical data from RBA, the graphical illustration of nominal exchange rate
movement of AUD in terms of USD for the last three years is represented as follows
(RBA, 2019a).

01/Mar/16
01/May/16
01/Jul/16
01/Sep/16
01/Nov/16
01/Jan/17
01/Mar/17
01/May/17
01/Jul/17
01/Sep/17
01/Nov/17
01/Jan/18
01/Mar/18
01/May/18
01/Jul/18
01/Sep/18
01/Nov/18
01/Jan/19
01/Mar/19
0.68
0.7
0.72
0.74
0.76
0.78
0.8
0.82
Exchange Rate Trend
Time
Exchange Rate (AUD/USD)
The graph above clearly highlights the stability and mild appreciation that AUD witnessed
during 2016 & 2017. This was the result of a stable economic growth that was witnessed in
Australia at that time. An enabling factor for this growth was a booming Chinese economy
which led to rise in mining exports. Owing to robust economic recovery, it was expected that
RBA would hike the cash rate by 25 bps in 2018. But this has not materialised on account of
slower than expected economic growth and deteriorating economic indicators for Australia in
the last one year (RBA, 2019b).
There are multiple factors which have led to the decline in AUD over the past one year. A
key factor is the growing concerns globally over a possible slowdown in major developed
economies particularly those belonging to Euro Zone, UK and Japan. This triggered
investment in US treasury bonds leading to higher demand of USD. Another enabling factor
of money inflow into US was the economic recovery witnessed in the US coupled with
change in stance by Federal Reserve (RBA, 2019b). Another issue which caused the AUD to
slide is the ongoing tariff war between USA and China. This has had a crippling effect on the
Chinese economy owing to which China had to deploy a massive stimulus package (Laursen,
2019). Chinese economy has direct impact on Australian economy owing to China being the
largest trading partner of Australia. Additionally, the expected rate hike from RBA has not
come through which furthered the fall in AUD against USD.

(c) A leading factor contributing to the falling AUD as per the article is the global slowdown.
This is particularly the case in Europe where new orders have dried up and manufacturing
PMI is on the decline. Additional data such as global manufacturing PMI has been falling
for the past eight months and has reached its lowest level in two years. Further, with the
US China tariff war and the subsequent concerns on Chinese growth, the slowdown fears
have accentuated. The result is that investors are increasingly become more risk averse
and are putting money in US treasury bonds. This is leading to higher demand for USD
coupled with relative strength of US economic recovery. Additional contributing factor is
the falling prices of commodities which assumes relevance in Australian context since
majority of its exports are mining based commodities. Hence, falling prices would hint at
lower exports and thereby slower GDP growth for Australia. Another contributing factor
in the AUD depreciation is the postponement of interest rate hike by RBA which was
widely expected to happen in 2018 but now seems unlikely before 2020 (Moore, 2019).
There has been an increase in the demand for USD as investors have an increase appetite for
US government debt owing to global uncertainty. Increased demand of USD against AUD
would lead to appreciation of USD and depreciation of AUD. Further, the lower prices of
commodities are expected to slow down economic growth in Australia. As a result, there
would be flight of foreign money from Australia to USA or emerging countries (Arnold,
2015). This lowers the demand for AUD as net foreign inflows would reduce and thereby
contribute to AUD depreciation. A similar scenario would be caused owing to postponement
of interest rate hike since this has made the debt market less lucrative for investors leading to
lower inflow of money in Australia (Mankiw, 2014).
(d)The current trend is that AUD is depreciating against the USD. This augers well for a
Australia based software exporter that has clients in USA. This is because the client would
pay in USD and the same would be converted into AUD by the software exporter.
Considering that the AUD has depreciated, hence for the same USD amount as previously,
the realisation in AUD would improve for the exporter (Barro, 2017). This can be
demonstrated through the use of a numerical example. Consider that the currency
exchange rate for AUD was 0.85 USD equals 1 AUD. As a result, a revenue of USD $8.5
million would imply AUD $10 million for the Australia based software exporter. Now
consider that AUD has depreciated owing to which 0.7 USD equals to 1 AUD. The
previous revenue of USD $8.cmillion would be AUD ($8.5 million/0.7) or $12.14 million.
It is evident that owing to AUD depreciation, incremental revenue to the tune of $2.14

million would be realised by the software exporter in Australia (McConnell, Brue and
Flynn, 2014).
Even though depreciation of AUD would bring windfall gains for exporters, but the imports
into Australia would get more expensive. For the exporters, there would be an increase in the
competitiveness since the exporters can reduce the increased windfall gains to reduce the
price and hence beat the competition. The incidence of expensive imports could potentially
be inflationary. However, on the whole, moderate depreciation of currency is positive for
Australia taking into consideration that it has a trade surplus. Despite the positive impact, it is
noteworthy that excessive depreciation can have adverse impact on the economy particularly
resulting in high inflation which needs to be avoided (Mankiw, 2014).
(e)The objective of RBA is to take suitable measure in order to ensure that the currency
exchange rate changes from the current rate of 1 AUD = USD 0.70 to 1 AUD = USD 0.73.
This would amount to appreciation of AUD against USD since in the latter case more
amount of USD is required to purchase 1 AUD. For enabling this shift in exchange rate,
there should be a change in the cash rate from 1.50% to 1.75%. This change in cash rate
would cause the interest rates to rise. As a result, the yields on the debt instruments would
improve. This would lead to a higher demand for these instruments from domestic and
foreign investors. In such a scenario, it is reasonable to expect higher foreign inflows into
Australia so take advantage of the higher interest being offered. This would lead to higher
demand for AUD which would lead to currency appreciation to the desired level
(McConnell, Brue and Flynn, 2014).
It is imperative to note that the action taken by RBA would have adverse implications for the
domestic economy. This is because the higher interest rates would imply an adverse impact
on the consumer spending. This is especially the case as consumers would be reluctant in
taking credit for various purchases as the finance cost has increased. Further, the incentive for
keeping the money in bank might increase owing to higher interest rate being offered
(Arnold, 2015). Lower consumer spending would also bring about a slowdown in the private
capital expenditure cycle. The combined effect of this would be felt on the GDP growth
which would slow down. Considering the fragile state of Australian economy at the money,
increasing the cash rate on part of RBA is not recommended (Dombusch, Fischer and Startz,
2016).

References
Arnold, A.R. (2015). Macroeconomics, 9thed. Sydney: Cengage Learning, pp. 84-87
Barro, R. (2017) Macroeconomics: A Modern Approach. 4th ed. London: Cengage Learning,
pp. 123-125
Chau, D. (2019) Australia's fortunes are linked to China's economy — for better or worse,
[Online] Available at https://www.abc.net.au/news/2019-01-15/china-economy-slowdown-
will-affect-australia/10716240 [Accessed 3 April 2019]
Dombusch, R., Fischer, S. and Startz, R. (2016) Macroeconomics. 10th ed. New York:
McGraw Hill Publications, pp. 98-100
Laursen, L. (2019) Why China Just Injected $83 Billion into Its Economy, [Online] Available
at http://fortune.com/2019/01/16/china-economy-83-billion-stimulus/ [Accessed 3 April
2019]
Mankiw, G. (2014) Macroeconomics, 6thed. London: Worth Publishers, pp. 87-90
McConnell, C., Brue, S. and Flynn, S. (2014) Macroeconomics: Principles, Problems, &
Policies. 20th ed. New York: McGraw Hill Publications, pp. 134-135
Moore, T. (2019) Australian dollar tumbles to ten-year low, [Online] Available at
https://www.smh.com.au/business/markets/australian-dollar-slides-below-us70c-20190103-
p50pbq.html [Accessed 3 April 2019]
RBA (2019a) Historical Data, [Online] Available at
https://www.rba.gov.au/statistics/historical-data.html [Accessed 3 April 2019]
RBA (2019b) Minutes of the Monetary Policy Meeting of the Reserve Bank Board, [Online]
Available at https://www.rba.gov.au/monetary-policy/rba-board-minutes/2019/2019-03-
05.html [Accessed 3 April 2019]