AUSTRALIA REAL EXCHANGE-RATE - IS IT EXPLAINED BY THE TERMS OF TRADE OR BY REAL INTEREST DIFFERENTIALS

We find weak evidence of a stable relationship between the Australian real exchange rate and the terms of trade from 1969 to 1990. Since the float, the terms of trade and long real interest differentials together help to explain the real exchange rate. Our best estimates are that a real exchange rate appreciation of about 0.3 to 0.5 per cent is associated with a 1 per cent improvement in the terms of trade, while an appreciation of about 2 to 3 1/2 per cent is associated with an increase of 1 percentage point in the differential between Australian and world long real interest rates.