Modelling the dynamics, structural breaks and the determinants of the real exchange rate of Australia

This paper examines the dynamics, structural breaks and determinants of the real exchange rate (RER) of Australia derived from an inter-temporal general equilibrium model. Autoregressive Distributed Lag (ARDL) modelling results show that a one per cent increase in: (1) terms of trade appreciates the RER by 0.96-1.05 per cent in the long-run; (2) government expenditure appreciates the RER by 0.53-0.46 per cent in the long-run; (3) net foreign liabilities appreciates the RER by 0.18-0.22 per cent in the long-run; (4) interest rate differential depreciates the RER by 0.007-0.01 per cent in the long-run; (5) openness in trade depreciates the RER by 1.15-1.31 per cent in the long-run; and (6) per-worker labour productivity depreciates the RER by 0.38-0.55 per cent in the long-run. The two endogenously determined structural breaks are positive but are statistically insignificant. The speed of adjustment towards equilibrium is high with short-run disequilibrium correcting by nearly 39-47 per cent per quarter. These results add new insights to the literature on the determinants of RER in Australia. Apart from the terms of trade, the effects of other determinants of RER are contrary to the results obtained in previous studies. (C) 2011 Elsevier B.V. All rights reserved.