Impact on fixed and variable exchange rates on the australian economy
‘An exchange rate is the price of one currency in terms of a second currency’ (Mahoney et al. ... The fixed exchange rate is defined as “an exchange rate that is pegged to a countries central bank” (Punnett and Ricks, 1997: 94). Under a fixed exchange rate system the price of a given currency doesn’t change in relation to each other currency. In order to understand the nature and workings of a fixed exchange rate system it’s best to use an example. ... However, the new equilibrium price yielded by the intersection of S1 and D could violate the responsibility of both Australia and the United States to maintain a fixed exchange rate of P-fixed. Therefore, central bank intervention by either the Reserve Bank of Australia (RBA) or US Federal Reserve Bank is required to restore the equilibrium price to P-fixed. ... 1: The Fixed Exchange Rate System (Mahoney, 2001: 200) This is done through one of three ways. ... When the RBA sells enough gold or $US and buys enough $AUD the demand curve will shift from D to D1, and P-fixed will be restored as the new equilibrium price (Mahoney et al. ... The P-fixed equilibrium price is then restored. The third method of intervention would include both the RBA and the US Federal Reserve Bank acting together by coordinating their policies to shift the demand curve for $AUD from D to D1, restoring market equilibrium price at P-fixed. ... Throughout history countries have needed some form of monetary exchange system in order to conduct fair business transactions. Since the early 20th century, growing trade between nations and globalisation have pushed the need for a stable exchange rate system through which fair trade can be conducted. This leads to the introduction of fixed exchange rates under the Gold System and Bretten Woods System, which provided stability to the international financial system until 1973 when the fixed exchange rate system proved insufficient to handle the rapid growth of markets. Many countries were then forced to switch to a variable exchange rate system in order to maintain market stability. In the one hundred years prior to WWI fixed exchange rates operated under the Gold Standard. The Gold Standard was the first fixed exchange rate system to be introduced and stabilized the international financial system because it provided a distinct medium of exchange by which paper currency could be used. ... ‘The gold standard created a fixed exchange rate system because each country pegged the value of its currency to gold’ (Mahoney et al. ... As long as firms held faith in a countries pledge to exchange gold for paper currency at anytime, many countries preferred to be paid in currency due to the excessive costs involved in the payment of solid gold.