Question

Assume that United States residents invest heavily in the Australian government and stocks. In addition, Australian residents invest heavily in the United States. Because your firm imports goods from Australia, you are assigned to forecast the value of AUD (the Australian dollar) against the USD – i.e., you forecast St(AUDUSD). Explain how each of the following conditions will affect the value of the AUD, holding other things equal. Then, aggregate all of these impacts to develop an overall forecast of the AUD’s movement against the USD. (Please plot a figure to explain each condition, except for question f. No figures, no points.)

a. U.S. inflation has suddenly increased substantially, while Australian inflation remains low.

b. The U.S. interest rates have increased substantially, while the Australian interest rates remain the same.

c. The income level in the U.S. increased substantially, while the Australian income level has remained unchanged.

d. The U.S. is expected to impose a new small tariff on goods imported from Australia.

e. In Australia, the recent dysfunction within the two major political parties has seen seven different Prime Ministers take office in the past decade. You expect that this situation may be going to get worse and assume Australia is not a safe haven.

f. Combine all expected impacts to develop an overall forecast.

Answer 1

a)In the first case U.S dollar has increased substantially and Australian inflation remains low.Hence the US dollar will start to depreciate and the Australian dollar will appreciate which means the value of Australian dollar increases.

b)As the interest rates of US has increased substantially and the interest rate of Australian dollar remains the same there will be more investment in US ,thus the Australian investors will invest more in US and hence the Australian dollar depreciates and the value of Australian dollar decreases.

C)As the income level of US has increased substantially and the Australian income remains unchanged there is more import of Australian goods by the US economy and hence the exchange rate of Australian dollar increases the demand for the Australian goods increases.

D)When the US imposes a tariff on imported goods there will be less demand for Australian goods and hence the Australian dollar demand also decreases and hence there is appreciation of Australian dollar take place.

D's graph is same as A's graph as the Australian dollar appreciates in both the cases.

E)The investors will feel less confident to invest in the Australian economy as there is high degree of uncertainty and as they dont find Australia a safe place to invest and hence there is a depreciation in Australian Dollar.

E's graph is same as option B as in both the cases there is a decrease in the value of Australian Dollar

F)To conclude with the investors will invest more in the US economy as compared to the Australian Economy as there is more uncertainty in the Australian economy
In general the value of Australian dollar is decreasing.