RDP 8713: Estimating the Inflationary Effects of Depreciation 6. Conclusion

This paper has presented some estimates of the effect of the recent depreciation of the $A on the Consumer Price Index. The estimated effects are substantial.

Placed in an international perspective, this is not surprising. The evidence suggests that the export prices of Australia's main suppliers have fallen in the recent past. Thus, had it not been for the depreciation, Australia would have been importing the effects not of world inflation, but of world deflation. This lowers the base against which the actual inflation rate is, ideally, to be compared, and makes the measured depreciation effect correspondingly larger.

Even so, the results suggest a larger response to exchange rate changes than had been found in most earlier studies. This is a plausible result, in view of the increased openness of the Australian economy over the sample period.

The findings also have implications for prospects for inflation in the near future. Given the finding that almost all of the price effects from the depreciations of 1985 and 1986 had passed by late 1987, and the fact that the Australian dollar has been more stable in 1987 than in the previous two years, it follows that most of the exchange rate effects upon the CPI should have passed by late 1987. If the currency remains relatively stable, any further imported cost pressures should be limited to those movements which occur in world traded goods prices. This implies that the major factor determining the differential between Australian and overseas inflation rates will be growth in Australian unit labour costs relative to those overseas. If growth in domestic labour costs is close to that in our major trading partners, there is a good prospect that the rate of inflation could fall into line with inflation rates in those countries.