International Capital Movements from an Australian Perspective

There has been recent interest in the role of capital flows in the process of exchange rate determination given the apparent breakdown of traditional relationships between fundamentals and currencies. This is true of the United States, Euro area and Japan, but also Australia. In this paper we do not attempt to settle the debate as to whether there is a theoretical justification for including capital flows in the analysis of exchange rate movements, nor do we attempt to find a role for capital flows in explaining the recent trends observed in the currency. Rather, the attempt here is to highlight that simplistic analysis of capital flows is unlikely to be helpful in furthering our understanding of exchange rates. While the balance of payments data may not be without information content, the complexity of the economic relationships reflected in the data needs to be appreciated. Some of these complexities are laid out in this paper. Some questions are answered, new questions are raised, and some loose threads are tied together.