Exchange rate paradox (1 Viewer)

[saves.the.day]

Could someone tell me the effect of an increase and a decrease in interest rates on the exchange rate.

So far, I was thinking about it and
Say interest rates increase.. that would foster business investment in the form of borrowing from other countries (say USA) so the supply of money decreases.. causing an appreciation

But then you think about a lowered interest rate, and that still fosters overseas business investment from other countries as they want to borrow money from us so it again reduces the supply of AUD and causes yet another appreciation.

I remember one is supposed to make an appreciation and one is supposed to depreciate but so far it looks to me both result in an appreciation.

Any Helps appreciated

 

[TastesGoodBut]

basically, if interest rates increase we will attract more foreign investment, casuing demand for the dollar to increase causing an appreciation...

as our interest rate differential with the USA is about 4% higher then them, we will attract more savings then them, causing our dollar to appreciate relative toe theirs

 

[clairegirl]

hey dude

the higher the INTEREST RATE the more overseass people (in this case The irish for example) are going to want to invest in australia because of the high return so they're like YAY look at australia it's got a High interest rate differential compared to Japan who's interest rate is close to 0.... and Australia's is 5% OOOOH MORE MONEY FOR MY IRISH BUM! if i invest in australia WHOO HOO!! so they they put their money in our country... which creates Demand for Australian dollars (becoz we dont want to be paid in bloody IRISH money mate we want the AUSTRALIAN DOLLAH!!) so this demand for more austrlian dollar.... causes an appreciation to our exchange rate......

hope that helps hehehe

 

[clairegirl]

hey dude sorry i didn't really realise that i didn't answer your question hehehe

urrm.... well ur question is kinda a bad example because Australia's interest rates are pretty high industrialised economies... and also Australia has low national savings... so it's better for overseas people to look elsewhere other than australia

So your example should be of Japan... who's interest rate is is 0.2.... so they got a low interest rate differenetial... so u'de think WHOO HOOO IT'S CHEAP TO BORROW FROM JAPAN... but yeah it would create demand for Yen which would cause an appreciation BUT it wouldn't be really significant...... and plus Low interest rates kinda mean that the economy is in a bad state.... and Japan is like full badness coz yeah they got high national savings..... but the thing is it's not in banks so they can't lend anyway

anyway i think im going heapz off track sorry hehehe

 

[Minai]

Originally posted by saves.the.day
Could someone tell me the effect of an increase and a decrease in interest rates on the exchange rate.

To sum up what everyone's been saying I guess...and to say it a different way..

If the Government uses its policies to increase the real interest rate, this interest rate increase will reduce net foreign investment (because people will want to save in their own country, instead of invest abroad), which then reduces the supply of $AU, causing the real exchange rate to appreciate.
This can be explained diagramatically too.

 

[spice girl]

the textbook reason is:

increase rates: o/s investors buy govt securities using AUD -> lack of AUD -> AUD rises

but in real life there are zillions of other factors. The AUD rises or falls due to speculation of what's happening.

a couple of days ago is a nice example: tuesday: US figures show record quarterly growth -> USD rises -> AUD falls
the next day: reserve bank announces rate rise: AUD rises about .75 of a cent

 

[kt san]

Originally posted by saves.the.day
Could someone tell me the effect of an increase and a decrease in interest rates on the exchange rate.

So far, I was thinking about it and
Say interest rates increase.. that would foster business investment in the form of borrowing from other countries (say USA) so the supply of money decreases.. causing an appreciation

But then you think about a lowered interest rate, and that still fosters overseas business investment from other countries as they want to borrow money from us so it again reduces the supply of AUD and causes yet another appreciation.

I remember one is supposed to make an appreciation and one is supposed to depreciate but so far it looks to me both result in an appreciation.

Any Helps appreciated

i think ur second part is a tad off
if aust. interest is low...then people want to borrow from Australia, so they'll be borrowing AUD, then exchanging it for their own currency, so there will be a high supply of AUD, and hence depreciation
cos e.g. US ppl won't borrow won't be spending money the borrow from Aust. in AUD, they want to borrow, but be investing in themselves in their own currency
if they currency is low, they may not necessary borrow to invest in australia, but just borrow from australia
cos if intests is LOW, then demand is LOW, and investment will be UNPROFITABLE, as it probably won't be consumed

 

[numg]

but what he means is if foreign investors borrow from australia, then the money supply in Australia is lowered, pushing up interest rates.

 

[spice girl]

wotcha gonna do with the AUD you borrow, but invest it? The money supply doesn't change. You can pretty much think of it as X (exports) increasing.

 

[Left-ism]

theres no definate answer for this because it real depends on so many real world, social and economic factors. However a higher interest rate differential will attract foreign SAVINGS into Australia hence increase demand for AUD and create an APPRECIATION. The fact that this may discourage foreign investors is likely to be untrue (depends more on the state of economy, inflation, growth, political environment, credit rating etc.),
because they will instead borrow overseas and then invest in Australia..which in turn will raise demand for AUD and hence create an appreciation.
Australia investors will be encouraged to borrow from overseas, but they will still need to convert borrowed funds into AUD to invest here hence creating an apprecitation again.
This will see you through the hsc course requirements.

 

[symo]

simply: decreased interest rates will:
1) decrease foreign savings (invest) inflows due to uncompetitive rates, decrewased demand for $A - depreciate
2) increase foreigners borrowing from Aust (theory yeah, but in reality prob not much), taking $A n converting it back to foreign currency, increasing $A supply - depreciate
right?

 

[saves.the.day]

Thanks Symo.. thats what i needed to know. Thankyou all for your responses, I understand it now

 

[monkey187]

another weird thing i dont really get about exchange rats is that
if the exchange rate goes up then imports become cheaper and exports become more expensive reducing out balance of goods and service worsening our CAD but then Net Income becomes better because its cheaper to service debt making our CAD better?? this also happens in opposite with a depreciating $$

so does and increase in the exchange rate worsen or better the CAD?

 

[Nick]

higher X rate will tend to better the CAD since the net income deficit is so huge, much bigger than hte trade balance..