Question

Suppose that the exchange rate stabilises at US 69C per AUD. What actions could the Reserve Bank of Australia take in order to bring the exchange rate to US 80C per AUD, and what side effects might this action have on the housing market?

Answer 1

The Reserve Bank of Australia can use it foreign exhange reserves to stabalise the exchange rate. When the exchange rate is US 80C per AUD instead of the desired value of US 69C per AUD, the Reserve Bank of Australia can sell US dollar in the exchange market for AUD currency. This would increase the supply of US dollar while increase the demand for AUD currency in the market. This would reduce the exchange rate and would lead to appreciation of the Australian currency.

As can be observed in the diagram, initially the economy was operating where S and D curves intersect giving the equilibrium exchange rate as E1 ie $ 80C / AUD and equilibrium quantity was Q1. When the Reserve bank of Australia use its official reserve and sell US $, the supply of US $ increases and supply curve shifts from S to S2 and the equlibrium exchange rate becomes E2 ie $ 69C / AUD and quantity of US $ in the market increases.

When the Reserve Bank sell US $ for AUD, the quantity of AUD in circulation increases in the economy and thus the cosumption and expenditure in the economy also rises. This would imply that the demand for housing would increase and thus the demand curve of housing would shift rightwards and there would ba an increase in the equilibrium price of the housing and equilibrium quantity would also rise in the housing market.