Australia's Deflation in the 1890s

The purpose of this paper is to examine two factors, gold production and export prices, that have been suggested as having aided Australia's escape from the deflation it faced in the early 1890s. In order to examine the factors influencing Australian domestic prices in the second half of the nineteenth century, annual data over the period 1861-1900 are used to estimate a structural vector autoregression. Causality tests in a reduced form vector autoregression suggest that two factors Granger cause the movements in Australian domestic prices, namely export prices and net exports. In contrast, movements in gold production in Australia do not significantly directly cause Australian domestic prices, but have some indirect effect through the interest rate and net exports. Impulse response functions computed from the structural vector autoregression suggest that shocks in export prices lead to a rise in domestic prices, but shocks in gold production do not. Perhaps surprisingly, an export price shock leads to a fall in net exports in the medium term. Changes in capital flows would appear to be an important adjustment channel.