Exchange rate movements and the Australian economy

• Published in: Economic modelling 2015-06, Vol.47, p.53-62
• Main Authors: Manalo, Josef, Perera, Dilhan, Rees, Daniel M.
• Format: Article
• Language: English
• Subjects: Australia; Currency revaluation; Economic models; Economic theory; Exchange rate; Exchange rates; Foreign exchange rates; GDP; Gross Domestic Product; Inflation; Interest rates; Local economy; Small open economy; Structural VAR; Studies; Terms of trade; Vector-autoregressive models
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2015.02.013

We use a structural vector autoregression model to characterise the aggregate and industry effects of exchange rate movements on the Australian economy. We find that a temporary 10% appreciation of the real exchange rate that is unrelated to commodity prices or interest rate differentials lowers the level of real GDP over the subsequent one-to-two years by 0.3% and year-ended inflation by 0.3 percentage points. The mining, manufacturing, personal services, construction and business services industries are the most exchange rate sensitive sectors of the economy. In the context of the boom in Australia's terms of trade over the past decade, we use our model to explore how the Australian economy might have evolved under alternative scenarios. These suggest that exchange rate movements over the past decade have had a stabilising effect on the domestic economy and can largely be explained by economic fundamentals. •We quantify the effects of exchange rate movements on the Australian economy•Exchange rate appreciations lower output and inflation•Trade exposed industries are the most responsive to exchange rate movements•Exchange rate movements have stabilised the Australian economy in recent years