Australian Dollar Appreciation

Readers Question: The Aussie dollar has appreciated strongly against the USD in recent times. Discuss the consequences of this rapid appreciation for Australia’s Balance of Payments?

The Australian Dollar has appreciated against the US Dollar because

• Large US current account deficit
• Australia has benefited from rising commodity prices, commodities which Australia produces a lot of.
• US interest rates are lower than Australia and the US economy has been weakening.

April 2008 $1 Aus Dollar = US 0.9300

Effects of AUS Dollar Appreciation

• It makes Australian exports more expensive. Therefore there will be a fall in demand for Australian exports.
• Imports into Australia will become cheaper, therefore there will be an increase in demand for imports.
• This is likely to worsen the current account deficit. However, this assumes that demand for exports and imports is relatively elastic. The Marshall Lerner condition states that if PED of exports + PED of imports > 1 then an appreciation will worsen the current account.
• In the short term demand is often inelastic, however over time consumers become more responsive to price changes therefore, the current account may improve in the short term, but worse, if the appreciation lasts for a long time.

Evaluation

• There are many other factors affecting the Australian current account apart from the exchange rate between US and Australia. For example, it depends on the value of the Aus dollar against its other main trading partners such as Japan and the EU.
• It also depends on the level of consumer spending and imports
• Ceteris paribus an appreciation in the AUS dollar will worsen the deficit. However, if demand for Australian commodities is inelastic (because there are no alternatives) then the deficit may not get much bigger.

Australian Current account deficit has averaged – 5.7% of GDP in 2007-08