Exchange Rate Movements and the Australian Economy

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 per cent appreciation of the real exchange rate that is unrelated to the terms of trade or interest rate differentials lowers the level of real GDP over the subsequent one-to-two years by 0.3 per cent 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 the 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 real exchange rate movements over the past decade have had a broadly stabilising effect on the domestic economy and can largely be explained by economic fundamentals.