Measurement of Relative Exchange Rates

Syllabus Topic

HSC Topic Two - Australia's Place in the Global Economy

Exchange rates

• measurement of relative exchange rates

  - to other individual currencies

  - Trade Weighted Index

Understanding Relative Exchange Rates

Relative exchange rates measure the value of one currency against another, reflecting how much of one currency is needed to purchase a unit of another. This measurement is crucial for international trade, investment, and economic policy. In Australia, the Australian Dollar (AUD) is frequently compared with currencies such as the US Dollar (USD), Euro (EUR), and Japanese Yen (JPY).

Publishing Exchange Rates

The exchange rate of the Australian Dollar (AUD) is updated alongside many world currencies daily. This allows for the most accurate data and statistics to be provided to those within the economy.

Direct and Indirect Quotations

Exchange rates can be expressed as direct or indirect quotations. Direct quotations show how much domestic currency is needed to buy one unit of foreign currency; for example, an AUD/USD rate of 0.75 means 1 AUD buys 0.75 USD. This method is useful for travellers and importers. In contrast, indirect quotations indicate how much foreign currency can be purchased with one unit of domestic currency; for instance, an EUR/AUD rate of 1.50 means 1 AUD buys 1.50 EUR. This approach helps exporters and investors assess the value of their domestic currency in foreign markets. Understanding both types is essential for effective currency management in international trade and finance.

Trade-Weighted Index (TWI)

The Trade-Weighted Index (TWI) measures the value of the AUD against a basket of currencies, weighted according to trade volume with Australia’s partners. The TWI provides a broader view of currency strength compared to bilateral exchange rates (the value of one currency in relation to another currency).

Calculation of TWI

The TWI is calculated using the exchange rates of the AUD against multiple currencies, weighted by the trade volume. For example, if Australia trades heavily with the US, China, and Japan, these countries’ currencies will have a more significant impact on the TWI. The formula for calculating the TWI is located on the RBA’s website.  

Current Example: Australia’s TWI

As of September 2024, Australia’s TWI was reported at 61.3 . This indicates a relatively strong AUD against a weighted basket of currencies, making imports cheaper and potentially impacting export competitiveness.

Real-World Implications

A strong AUD can have mixed effects on the Australian economy. For example, in 2023, the AUD appreciated against the USD, reaching around 0.70 USD. This appreciation made Australian exports, especially in mining and agriculture, more expensive for foreign buyers, potentially reducing demand. Conversely, imports became cheaper, benefiting consumers and businesses reliant on foreign goods.

Conclusion

The measurement of relative exchange rates, particularly through trade-weighted indices, is vital for understanding Australia’s economic landscape. By analysing the AUD's performance against a basket of currencies, policymakers and businesses can make informed decisions that impact trade, investment, and overall economic stability. The TWI and exchange rate fluctuations play a significant role in shaping Australia’s monetary and trade policies, influencing everything from export competitiveness to consumer prices.

Sources

Investopedia: International trade

Britannica: Economic Policy

RBA: Trade-Weighted Index (TWI)

RBA: Exchange Rates of the AUD

RBA: Calculating the TWI