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What is a good systematic review process to assess the worlds' macroeconomic condition?

Economics

What is a good systematic review process to assess the worlds' macroeconomic condition?

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We have discussed the macroeconomic scenario and analysis of Australia. We can augment the same kind of analysis to the world economy.

In the demand-supply model of exchange rate determination, the demand and supply of foreign exchange determine the exchange rate of the home country. So, this is a classical model and the exchange rate is the price of the model. The quantity of foreign exchange demanded and supplied interact with each other and equilibrate at the equilibrium price or market forces determined the exchange rate in this model. An exchange rate means a relative price of Aud versus the USD. It tells us how many Aud to give up to get one USD. So, the exchange rate tells us the relative price of Aud in USD.

The AUD-USD rate had depreciated from 0.72 in April 2016 to 0.81 in January 2018 and thereafter appreciated to 0.70 till the current day. So, the rate of depreciation has been about 10 % while the rate of appreciation has been 12%.

So, what are the factors that determine the Aud USD rate movement?

Firstly the global growth forecast. Better the global and US growth forecasts, higher the dollar will appreciate. The money will flow out from the US to other economies and risk aversion will decline and Dow Jones will rally. Foreign inflows of capital will rise in the US. But domestic exchange rates will appreciate in the second round effects leading to Aud USD appreciation. So, in 2016-17 it was a high-risk aversion story with capital flight from Eurozone, OECD countries and Ems and money entering the US. USD was appreciating. This led to weakness in the Aud USD rate and 10% depreciation in the Aud rate. From January 2018 till date, things which were looking murkier have brightened up and most economies in the world have seen good news and brighter data resulting in their economies getting lifted out of recession. So, money is again flowing into the Ems, Eurozone, OECD countries from the US and risk appetite is increasing. So, Australia to is a beneficiary of this and Aud rate has recorded the appreciation of 13%.

Movements of Australia's commodity prices.

Prices of commodities determine movement in Aud-USD rate. If commodity prices rise it means inflation in the economy will rise above the central bank's comfort zone and interest rates would harden and spiral up. This is RBA's response to tame inflation. So if interest rates harden, growth will be mitigated as investments decline and recession may set in leading to collapse of the Australian economy.the interest rates have to be declined in recession times to accommodate growth.

The interest rate differential between Australia and the US.

This is referred to as the covered interest rate parity. If the interest rate differential between Australia and the US rises/declines, the Aud USD rate will appreciate/depreciate. This is because the forward Aud USD pair will appreciate.

Asian economies

Expansion in China has seen Aud USD rate rally to higher values. This is because three-quarters of Australia's exports are to Asian economies. So when there is a boost in demand in Asian economies, Australian exports rally and the currency appreciates. This was true in 2000-2010 when China was growing vociferously. When there is slack in China or in some Asian countries, the Australian dollar will depreciate.

For a software exporting firm in Australia, Aud depreciation will lead to increase in export earnings because software products are priced in dollars and exporters while encashing in aud will have to convert dollars at higher aud rates leading to better earnings. For 1 dollar, previously the firm was getting say 70 aud. Now it is getting 85 aud due to softening of the aud usd rates. The software exporting firm will focus all its efforts in targeting the company?s selling the software products to the uS clients rather than delving on local issues and thus maximize its profits and escalating its earnings. It will step up marketing efforts, human capital endeavors to maximize earnings. If aud depreciation leads to better EBITDA for the firm, share prices will boom and thus this will lead to higher market capitalization and higher net worth and greater wealth creation. Reserves and surpluses too will zoom higher in the process leading to better share prices. Revenues too have risen in the process and this means higher sales have been achieved.

Depreciation of aud will have what impact on the general economy is explained in this section. Export earnings will rise and import costs will decline causing current account deficit to decline and balance of payments to improve.

If the exchange rate is to appreciate from US 70 c/aud to US 73c/aud, the Reserve bank of Australia or the RBA could raise the interest rate in the economy to create significant differential between Australia and the US so the capital flows into Australia, foreign inflows purchase Australian stocks and bonds and commodities too investment rises. If asset prices rise the aud gets further boosted and further capital flows in leading to glut of forex currencies in the forex markets and higher demand of aud leading to an appreciation of the Aud-USD rate. If interest rates in Australia are raised by the RBA, domestic bonds get attractive than US counterparts and in a global declining risk scenario, capital will flow from foreign countries to the domestic economy and aud will appreciate.

As interest rates are raised there will be a decline in investment and government spending and declining of growth in the economy. Exports will decline, imports will rise because of aud appreciation, so GDP growth will be greater affected. Current account deficit will worsen and thus this will result in a worsening of the balance of Payments situation in the economy. As interest rates are raised, bonds will become attractive and stocks will decline as loans for corporate become dearer. Market borrowings will increase as interest rates are raised and hence budget deficit will rise. The budget deficit is nothing but the government debt to the public and corporates. Assets returns will like stocks and bonds and commodities to foreign investors will increase in currency-adjusted terms as exchange rate has appreciated and will foreign investors redeem their assets and take the proceeds to their home accounts will have to buy their own currency and now with declining quantity of aud they can purchase higher amounts of the foreign currency or their home account currency.

On commodities, lets see the effect. Commodities are export products. So appreciation of aud will lead to declining income from exports and as Australia is a commodity exporter to Asian economies, its export earnings will be hampered. Thus investors both domestic and foreign will find declining interest in commodities as an asset class.

In the ISLM model, toughening monetary policy will lead to the leftward shift of the LM curve and interest rate rises and growth declines. If the IS curve is less steep, that is if savings propensity is declining and investment response to the interest rate is high, the rise in interest rate is less affected and GDP declines slowly. In the opposite case, the GDP? decline is worse.