exchange rates (1 Viewer)

[*Pooja*]

ok...tru or false?

The ability to maintain an undervalued exchange rates depends on the level of foreign reserves.

and an explanation pls.

 

[grimreaper]

umm well it depends really... the government can use foreign reserves to buy $, therefore reducing supply of $ and driving the exchange rate for $ up. However, this is not the only tool for doing this - they also may increase interest rates to encourage foreign investment in the domestic economy, which will also drive the value of $ up. So to answer your question, yes it can depend on foregin reserves if the govt wants to stabilise the currency without using interest rates

 

[George W. Bush]

If we are talking about a fixed exchange rate , the currency (let's just say AUD, even though it is floating) will be undervalued if demand exceeds supply - thus the central bank must sell AUD (i.e. buy foreign currency) to keep it at this level which will increase the level of foreign reserves.

If the currency is overvalued, the supply of AUD exceeds the demand of AUD, thus the central bank needs to buy AUD (i.e. sell foreign currency) to keep it at this level, reducing its level of foreign currency reserves. Eventually, these foreign currency reserves will run out (e.g. Asian Financial Crisis), forcing a devaluation of the currency or a float (generally before it gets to this extreme stage).


If the currency is floating, it's not really over or undervalued - these terms generally refer to market equillibrium price compared to actual price. However, one can consider the currency over or undervalued in terms of how much it is worth taking into account the fundamentals of the economy, although the RBA intervention, I believe, is generally to smooth out fluctations.

With the floating rate, the central bank can enter the forex market as a buyer or seller (termed 'offical intervention in the forex market) to influence the exchange rate as laid out above, either directly or getting another central bank to act on its behalf.

the government can use foreign reserves to buy $, therefore reducing supply of $ and driving the exchange rate for $ up

This is WRONG, and you will lose marks for writing this in the HSC - the governmen entering the market increases the demand, rather than reducing the supply. What he means is that they buy up the extra supply, but you will lose marks for that.

The RBA also influences the exchange rate through the sale of 2nd hand gov't securities, as grimreaper said. With a higher exchange rate, there is increased investment in interest bearing assets in Australia (read bonds), causing increased demand for the currency, and reduced capital outflow.

Lastly, the RBA can try to turn around market sentiment by the release of some offical annoucement talking up the currency. This is the most simple to understand of the three processes - basically the RBA advertises the dollar in the hope of changing perceptions. This is commonly refered to as 'jawboning'.

 

[grimreaper]

Originally posted by George W. Bush

This is WRONG, and you will lose marks for writing this in the HSC - the governmen entering the market increases the demand, rather than reducing the supply. What he means is that they buy up the extra supply, but you will lose marks for that.

%$*&^#....... I'm sorry I look like such a retard now, I was tired when i wrote it . But yeah youre right haha sorry if I confused anyone with my wrong answer

 

[*girl04*]

depends on a variety of factors

 

[tradewind]

govt via the RBA helps influence the exchange rate

 

[aditya]

TRUE -

such activity it is limiited be the the amount in the RBA's "bag of money"... if they sell AUD (ie. buy a foreign currency using $AUD), this will increase the supply of aud and hence result in a depreciation (through reduced demand), or a stabalisation ( i made that word up so dunt use it, just to give u the picture)... if they buy AUD from the FOREX market through the use of their foreign exchange reserves... then this will reduce the suppply of the AUD on the world market (infulencing demand - increasing it) and result in an appreciation.... these changes arent significant, only within a few dollars... but it all depends on how large the bag of money is... it is possible to exhast the bag of money... but im not sure if it has ever occured (someone tell me)

while we're on the topic: could somebody expalin sterilisation?

 

[aditya]

Originally posted by *girl04*
depends on a variety of factors

u sure u know wat ur talking about?

 

[George W. Bush]

Originally posted by aditya
<stuff>

The country that started the Asian Financial Crisis ran out, I think. Can't remember which one it was - Thailand, i think. India also came within 2 weeks in 1991

while we're on the topic: could somebody expalin sterilisation?

Recall money supply from prelim eco - RBA funds aren't part of the money supply. By selling AUD they are adding to money supply - inflationary. By buying they are reducing money supply - deflationary. Stelisation just adds/takes the money back.



EDIT: pwned by VB.

 

[grimreaper]

Yes the Asian financial crises began with the depreciation of the Thai Baht, so I assume the govt ran out of foreign reserves to keep it up in value...... Oh and I'm fairly sure I'm right this time

 

[ameh]

Originally posted by George W. Bush
If we are talking about a fixed exchange rate , the currency (let's just say AUD, even though it is floating) will be undervalued if demand exceeds supply - thus the central bank must sell AUD (i.e. buy foreign currency) to keep it at this level which will increase the level of foreign reserves.

If the currency is overvalued, the supply of AUD exceeds the demand of AUD, thus the central bank needs to buy AUD (i.e. sell foreign currency) to keep it at this level, reducing its level of foreign currency reserves. Eventually, these foreign currency reserves will run out (e.g. Asian Financial Crisis), forcing a devaluation of the currency or a float (generally before it gets to this extreme stage).


If the currency is floating, it's not really over or undervalued - these terms generally refer to market equillibrium price compared to actual price. However, one can consider the currency over or undervalued in terms of how much it is worth taking into account the fundamentals of the economy, although the RBA intervention, I believe, is generally to smooth out fluctations.

With the floating rate, the central bank can enter the forex market as a buyer or seller (termed 'offical intervention in the forex market) to influence the exchange rate as laid out above, either directly or getting another central bank to act on its behalf.



This is WRONG, and you will lose marks for writing this in the HSC - the governmen entering the market increases the demand, rather than reducing the supply. What he means is that they buy up the extra supply, but you will lose marks for that.

The RBA also influences the exchange rate through the sale of 2nd hand gov't securities, as grimreaper said. With a higher exchange rate, there is increased investment in interest bearing assets in Australia (read bonds), causing increased demand for the currency, and reduced capital outflow.

Lastly, the RBA can try to turn around market sentiment by the release of some offical annoucement talking up the currency. This is the most simple to understand of the three processes - basically the RBA advertises the dollar in the hope of changing perceptions. This is commonly refered to as 'jawboning'.

pretty good for a C average student

 

[George W. Bush]

This is Yale we're talking about, not the University of Southern Kentucky.

 

[becany]

Direct intervention by the RBA in the FOREX market has potential implications for domestic liquidity. Therefore, they may chose to sterilise or unsterilise...sterilisation is when the central bank offsets its FOREX market intervention by buying/selling the equivalent amount of government securities, leaving the monetary liabilities of the central bank unchanged. Unsterilised FOREX market intervention does not involve the subsequent purchase/sale of government securities, and thus, such a sale of foreign currency will lead to a fall or rise in the money supply and interest rates.

The RBA has always undertaken sterilised intervention because after they buy $A, it would replenish the cash in the banking system so that there is no effect on interest rates or the stance of monetary policy. This is done by buying Commonwealth Government Securities in its DMO; or arranging a foreign currency swap.