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. (7 points)

b. The U.S. interest rates have increased substantially, while the Australian interest rates remain the same. (7 points)

c. The income level in the U.S. increased substantially, while the Australian income level has remained unchanged. (7 points)

d. The U.S. is expected to impose a new small tariff on goods imported from Australia. (7 points)

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. (7 points)

f. Combine all expected impacts to develop an overall forecast. (2 points)

Answer 1

Answer:

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

Demand for AUD should increase, supply of AUD for sale should decrease, and the AUD value should increase as compared to USD.

.

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

Demand for AUD should decrease, supply of AUD for sale should increase, and the AUD value should decrease as compared to USD.

.

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

Assuming no effect on U.S. interest rates, demand for USD should increase, supply of USD for sale may not be affected, and the USD value should increase as compared to AUD.

.

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

Demand for USD should not be affected, supply of USD for sale should increase, and the value of USD should decrease as compared to AUD.

.

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.

Demand for AUD will decrease, supply of AUD for sale should increase, and the value of AUD should decrease as compared to USD.

.

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

Overall it can be said that value of AUD will decrease as compared to USD and so imports will become cheaper for the firm.