o/s borrowing & foreign investment on AUD value (1 Viewer)

[indeed]

Hello,

if interest rates increase in AUS (but no where else globally), would that increase OR decrease the value of AUD
(cause on one hand, it means more overseas borrowing by aus, causing increase supply of AUD, decrease AUD value - this is most of the time the only pov teachers cover i think;
on the other hand, it means more inward foreign investment, causing more demand of AUD, increase AUD value)

Thanks!

 

[jimmysmith560]

Essentially, if interest rates in Australia increase, the effects of this can be observed in two different ways:

• For Australians, higher interest rates mean higher borrowing costs. Because of this, Australians would eventually start spending less. This in turn decreases the demand for goods and services, causing inflation to fall. When inflation is low, the value of the AUD increases. For Australians, this leads to an ability to purchase more with less money.
• In terms of foreign entities, your explanation is accurate. Higher interest rates tend to attract foreign investment, which increases the demand and the value of the AUD. An example would be the enticing opportunity to earn significant interest on funds coming from foreign investors that are deposited in Australian bank accounts.

This information allows you to effectively argue that an increase in interest rates in Australia results in an appreciation of the AUD. With that being said, I am not entirely sure of the point that argues that higher interest rates result in a depreciation of the AUD. Perhaps someone else could provide insight in that regard. Additionally, I did not take Economics, meaning that the above information is more general. For this reason, I would recommend referring to the Economics syllabus to ensure that you are aware of the dot point(s) relevant to this and confirm any details with your teacher if necessary.

I hope this helps!

 

[mmmmmmmmaaaaaaa]

Essentially if interest rates were to increase domestically but were to remain constant globally (ceteris paribus), this would cause what is known as an interest rate differential. This basically means that more foreign investment will enter into Australia as they seek to gain more on the investments (ie. it’s more attractive. Therefore as the demand for the dollar increases, this will appreciate the currency

 

[No surprises]

Why would there be more overseas borrowing by aus pls explain a bit...I feel like know 0 economics.

 

[No surprises]

If it's me I would say appreciation, because as you said, higher interest rate means attrats others to invest in aus.. but it means there might be a higher NPY deby -->larger CAD which may result in less investors confidence -->less demand-->depreciation...? So maybe you need to talk about both side, in terms of short/long term.
PLS correct me if I am wrong cuz I am sucks at this topic

 

[gazzaboy]

A meta point about economics: there is almost always a way to argue both ways in theory, especially if you use enough "links". It's more true for variables like exchange rates, which are subject to multiple factors. It's really hard to pinpoint exact cause-and-effect relationships in economics because nothing is really "ceteris paribus" in real life, and it also depends on the time period in which you look at it.

That being said, the main way that people argue that an increase in interest rates leads to an appreciation is the asset attractiveness point i.e. higher interest rates means Australian assets are more attractive which leads to an increase in the demand for Australian dollars to purchase such assets.

The "more overseas borrowing" point is harder to argue, because more borrowing from overseas actually increases demand for AUD because once you borrow in the foreign currency, you would need to convert it to AUD to use it, which increases demand for AUD.

The argument of "higher interest rates → more investment in Australia → greater NPY deficit → larger CAD → lower investor confidence → lower demand for AUD → depreciation" is probably a bit too indirect.

(The below information is not in the HSC syllabus but nice to know)
However... in practice, when the cash rate increases, the exchange rate doesn't appreciate noticeably. You can go and check yourself by looking at:

• When the cash rate target changed: RBA
• AUDUSD: Yahoo Finance

For example, on 7 June 2023, the cash rate increased by 0.25%, but actually after the 2:30pm announcement, AUDUSD depreciates immediately after, but then recovers back after a day or so.



It's outside the scope of the syllabus to explain the exact micro movements of the exchange rate, but one reason why it doesn't hold up in practice is because the cash rate change is already "priced in" - that is, people already expected the cash rate to rise so they already acted on the decision before the actual cash rate change announcement. This is a reflection of the efficient market hypothesis. Another possible reason is that markets are irrational and react to unexpected news. For example, many investors did not expect the cash rate to increase in Australia in the June meeting, and the surprise may have caused a minor sell-off in the currency.

 

[indeed]

A meta point about economics: there is almost always a way to argue both ways in theory, especially if you use enough "links". It's more true for variables like exchange rates, which are subject to multiple factors. It's really hard to pinpoint exact cause-and-effect relationships in economics because nothing is really "ceteris paribus" in real life, and it also depends on the time period in which you look at it.

That being said, the main way that people argue that an increase in interest rates leads to an appreciation is asset attractiveness point i.e. higher interest rates means Australian assets are more attractive which leads to an increase in the demand for Australian dollars to purchase such assets.

The "more overseas borrowing" point is harder to argue, because more borrowing from overseas actually increases demand for AUD because once you borrowed in the foreign currency, you would need to convert it to AUD to use it, which increases demand for AUD.

The argument of "higher interest rates → more investment in Australia → greater NPY deficit → larger CAD → lower investor confidence → lower demand for AUD → depreciation" is probably a bit too indirect.

(The below information is not in the HSC syllabus but nice to know)
However... in practice, when the cash rate increases, the exchange rate doesn't appreciate noticeably. You can go and check yourself by looking at:

• When the cash rate target changed: RBA
• AUDUSD: Yahoo Finance

For example, on 7 June 2023, the cash rate increased by 0.25%, but actually after the 2:30pm announcement, AUDUSD depreciates immediately after, but then recovers back after a day or so.

View attachment 38989

It's outside the scope of the syllabus to explain the exact micro movements of the exchange rate, but one reason why it doesn't hold up in practice is because the cash rate change is already "priced in" - that is, people already expected the cash rate to rise so they already acted on the decision before the actual cash rate change announcement. This is a reflection of the efficient market hypothesis. Another possible reason is that markets are irrational and react to unexpected news. For example, many investors did not expect the cash rate to increase in Australia in the June meeting, and the surprise may have caused a minor sell-off in the currency.

Oh ok yeah that makes sense, thank you so much!