Publisher University of Piraeus. International Strategic Management Association
Abstract
Recent evidence indicates that Australia's real effective exchange rate, its terms of trade
and a long-term real interest rate differential form a cointegrating relationship. This paper
uses this evidence to analyse the nominal US/A exchange rate. The US/A rate is found
to be cointegrated with the terms of trade and relative price levels. However, interest rate
differentials appear to add nothing to this long-run relationship. Estimated error correction
models suggest that there is a substantial two-way relationship between nominal exchange
rate changes and changes in the terms of trade. This evidence indicates that the small, open-economy
assumption of exogenously given terms of trade may be inappropriate when modelling
movements in the US/A exchange rate. Changes in a long-run interest rate differential,
possibly reflecting differences in expected inflation rates, contribute significantly to
an explanation of short-run changes in the nominal exchange rate.peer-reviewe
