How low will the Aussie dollar go?

After weeks of rapid depreciation, many commentators are wondering just how low can the Australian dollar go.

Slowing growth in China and signs of a recovery in the US have renewed pressure on the dollar, with some predicting that it could fall below US90 cents this week as encouraging US jobs figures strengthen the greenback. Analysts from investment bank Credit Suisse have been more bearish in their 12-month outlook, forecasting that the dollar could slide to a low of US75 cents.

Here are three leading academics on the fundamental value of the Australian dollar and what the future might hold for our exchange rate:

Mark Crosby, Associate Professor of Economics at Melbourne Business School:

Short-term estimates of the exchange rate are notoriously unreliable. A large amount of research, with an original paper being one in 1988 by the former chief economist at the IMF, Michael Mussa, has suggested that the exchange rate is a random walk.

A pure random walk is completely unpredictable. No variable helps predict movements in a random walk, and past behaviour is no guide to future trends. With the AUD, I still believe that a random walk forecast for the currency is your best bet at horizons out to a year or two. In other words, with the current value for the AUD being 91 cents, the best forecast for the AUD in a year or two would be 91 cents. Having said this, expect to be wrong! One year in 10, a forecast of 76 cents to $1.06 would still not contain the value of the exchange rate in a year.

In the current environment, the further weakening of China’s economy and commodity prices would increase the likelihood of the lower value, while improvements in the outlook for China would move the AUD back towards parity or above. At a longer horizon, it does make some sense to think about a fundamental value for a currency. The fundamental, or equilibrium exchange rate, is a value that will maintain a sustainable trade and current account balance.

This fundamental value will move around with things like a country’s rate of inflation, and also will change as the terms of trade moves. Higher export prices will tend to make a higher value of the currency sustainable. I’m not aware of any estimates for a fundamental exchange rate for Australia, but my back of the envelope calculations would have the fundamental for the AUD at around 75 cents to 80 cents. However, one should not necessarily expect the dollar to return to that kind of level any time soon.

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