The IPA weekly update, Hey, has a great picture.
Data are here.
Has the Aussie fallen relative to other commodity currencies because
(a) the new mining tax?
(b) the Rudd government’s debt and deficits?
(c) both (a) and (b)
(d) evil neo-liberal economics?
(e) don’t ask me, I voted liberal?
Update: Some of the comments in the thread suggest the graph is ad hoc. In one sense it is, afterall it is just a graph of prices. But there is a serious question to be asked and answered and some are calling for theoretical guidance. Under some basic assumptions it is possible to derive the flex-price exchange model. This model suggests that the relative demand and supply of money determines the exchange rate. So assuming that purchasing power parity holds true in both the short-run and the long run and uncovered interest rate parity holds true (domestic and foreign bonds are perfect substitutes) we can set off.
(That derivation comes from Hallwood and MacDonald – I taught out of this book for a few semesters until the students complained it was too hard and then moved to Pilbeam.)
So the exchange rate is a function of relative money supply, relative income and relative interest rates. Increases in st imply a depreciation and decreases in st imply an appreciation (to go down is to appreciate). Some of the comments in the thread imply that all the action is in (i – i*) – if the RBA were to stop increasing interest rates or even lower them then that could cause the Aussie to decline. That is an explanation. Another explanation is that an economically irresponsible government would cause a relative decline in Australian national income through an expansion of the state at the expense of the productive sector of the economy i.e. (y – y*) could increase, leading to a depreciation relative to other currencies.
Okay, so what about the relative interest rate story? We have a very nasty looking yield curve here. So that could be part of the story. This raises the question, why is the Australian economy vulnerable to events in far away Greece? Or even Euroland? Why has our currency depreciated vis-a-vis the New Zealand dollar?