Quick questions on The Australian dollar exchange rate: determinants and effects (HSC Economics Topic 2)

The exchange rate is the price of one currency expressed in terms of another. Three regimes:

The foreign exchange market for AUD has:

The standard diagram has the AUD price (USD per AUD) on the y-axis and quantity of AUD on the x-axis. A rightward shift in demand for AUD (or leftward shift in supply) raises the equilibrium price (appreciation). A leftward shift in demand (or rightward shift in supply) lowers it (depreciation).

1. Commodity prices and the terms of trade. Australia's exports are commodity-intensive. A rise in iron ore prices raises foreign demand for AUD. The AUD/USD correlates strongly with the terms of trade (correlation coefficient roughly 0.7 over the past 20 years).

The RBA can intervene in the foreign exchange market by buying AUD (to support the rate) or selling AUD (to weaken it). The RBA holds around AUD 70 billion in foreign exchange reserves. Intervention is rare because the floating rate generally absorbs shocks well; the RBA last intervened heavily during the 2008 GFC to stabilise the AUD.

The AUD/USD has ranged from a low of USD 0.55 (March 2020 COVID shock) to a peak of USD 1.10 in mid-2011. It has traded in a USD 0.62 to 0.70 range through much of 2024-25, reflecting:

Australia's exports are commodity-intensive. A rise in iron ore prices raises foreign demand for AUD. The AUD/USD correlates strongly with the terms of trade (correlation coefficient roughly 0.7 over the past 20 years).

When Australian interest rates are higher than overseas, foreign investors demand AUD-denominated assets. The "carry trade" is a major source of AUD demand. The RBA-Fed rate differential is a key driver.

Currency traders speculate on AUD movements based on macro data releases (US Fed announcements, ABS inflation, RBA decisions). About 90 percent of daily forex turnover is speculative rather than trade-related.

Strong Australian growth relative to overseas attracts capital inflow and supports the AUD.

Persistent higher Australian inflation reduces the AUD's purchasing power, putting downward pressure on the nominal rate (purchasing power parity).

Geopolitical shocks affect risk-on or risk-off sentiment. The AUD is a "risk-on" currency: it weakens during global crises (March 2020 fall to USD 0.55) and strengthens during global recoveries.

The RBA holds foreign exchange reserves to intervene if the AUD is "disorderly" (extreme volatility). Direct intervention is rare; the RBA last intervened heavily in 2008.

It is upward sloping. Australians supply more AUD to the forex market when the AUD price is higher (because foreign goods are cheaper in AUD terms).

Appreciation hurts exporters but helps consumers and reduces inflation. Markers reward balanced analysis.