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The Australian dollar has been one of the world's best performing currencies in recent weeks, and the Reserve Bank is comfortable with that. But not all economists agree it is trading at sustainable levels.
RBA governor Philip Lowe used a public appearance on Thursday night to signal his ease with the Australian dollar's strength.
Is the Australian dollar too high? It depends on what measure you use. Photo: Louie Douvis "It's hard to say that the exchange rate is fundamentally too high," he said in response to an audience question at the A50 dinner. That might change, he said, were the global outlook or global interest rates to shift. But on present circumstances, "I struggle to say the configuration
is leading to growth outcomes that aren't satisfactory." The Australian dollar traded a third of a cent higher on Mr Lowe's remarks, but had slipped back down to US76.3c by Friday morning. In the year to date, the Australian dollar is up 6 per cent against the US dollar, 5 per cent against the Chinese renminbi, British pound sterling and Indonesian rupiah, 4 per cent against the European euro and 2 per cent against the Japanese yen.

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On Westpac's models, the Australian dollar is slightly undervalued. This comes after the RBA, in its statement on interest rates on Tuesday, said the lower dollar since 2013 had been helpful in transitioning the economy through the end of the mining investment boom. "An appreciating exchange rate would complicate this adjustment," the statement noted.
Trade-weighted index
NAB currency strategist Rodrigo Catril said that the statement doesn't note that the Australian dollar has been appreciating, steadily, since September 2015. The bank uses a trade-weighted index measure of the Australian currency to gauge its appropriate level. It compares the Australian dollar against a basket of currencies, and then weights those individual currency contributions depending on how much Australia trades with the relevant currency (a quarter of its weighting is assigned to the Chinese renminbi, 11 per cent to the US dollar and 10 per cent to the Japanese yen). "It's true that the AUD to US dollar is little changed over the year," Mr Catril said. "But when you look at the Australian dollar on a trade-weighted basis, it has risen quite significantly." The Australian dollar is up 4 per cent over the year to date on a trade-weighted index basis.
Australia's terms of trade have risen strongly in the past year, which should lead the currency to appreciate, he added. "But the rise in the trade-weighted index is larger than would be expected for terms of trade." Econometric modelling conducted by Westpac's chief currency strategist Robert Rennie gives a different conclusion. He uses a 'fair value' econometric measure of where the currency should be, which takes into account interest rate differentials, commodity prices and measures of risk. He runs 10 different models with slightly different risk measures, and averages them out to come up with a 'fair value' band one standard deviation on either side.
Under this modelling, the Australian dollar is actually slightly undervalued. "Anyone that's done any econometric work would know that depending on the period that you run your models, and the weighting of your models, you're gonna get a different outcome," Mr Rennie said. "That's why I run 10." Like Mr Lowe, Mr Rennie said the dollar wasn't overvalued. But he acknowledged this might change. If the US Federal Reserve raises interest rates this year, while the Reserve Bank does not, it would lead to a recalibration. He also suggested markets were, for the most part, underpricing the risks to the Australian economy, which meant it wasn't showing up, yet, in his models. "We live in a world of tariff and trade conflict – that's not good for the AUD."
From the article titled ‘Is the Australian dollar overvalued?’ (Sydney Morning Herald February 10, 2017), answer the following questions. Note that your analysis is based on US Dollar (USD) and Australian Dollar (AUD).

(a) Briefly summarise the main issues discussed in this article? [Not exceeding 300 words] – (20 Marks)

(b) Using Demand and Supply model of exchange rate determination briefly explain how AUD is determined in the forex market, and what factors influence its fluctuations. – (20 Marks)

(c) Using nominal exchange rate data and trade weighted index from Reserve Bank of Australia and graphs (monthly data of last three  years) analyse the movement of AUD relative to that of the USD? Is it in line with the world commodity price movement during
     this period? Are there any other factors contributing to this behaviour of the AUD? – (25 Marks)

(d) Assume that you are exporting alcoholic beverages to United States. Explain the impact of overvalued AUD on your income? What  advantages/disadvantages do you think Australia will have in overvalued AUD? – (15 Marks)

(e) If the market rate is US 76C then what action could the Reserve Bank of Australia take in order to maintain the exchange rate at US 72C, and what side effects might this action have on the Australian economy? Do you think that such actions would be effective? – (20 Marks)

Word Limit: 2000 words maximum. Word count (excluding references) must be provided.
Excess words will not be marked.
1. This assignment is marked out of 100 and is worth 20 per cent of overall marks.
2. At least 5 relevant references are required regarding the issue featured in your allocated topic.
3. Turnitin Report: It will be compulsory for all students to submit the written assignment (final version) into the Turnitin system before submitting the hard copy to the tutor. Students are encouraged to submit drafts of the assignment before the due date, enabling students to check their referencing and rectify any issues before submission of the final version.

a. In the absence of the submission of the Turnitin report, a zero mark will be awarded for this                   assignment task.
b. A similarity index of less than 10 per cent is expected in your assignment. Zero tolerance applies         for plagiarism
4. Hand in your hard copy of the assignment to the tutor on or before Week 8 of Trimester 3/2017.           Penalty applies for late submission.
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