Australia’s terms of trade (the price of its exports relative to the price of its imports) is on a 140 year high. This is a huge positive for Australia, in the sense that we can buy more imports for a given level of exports.
Average 1869/70 to 2010/11 = 100. Source: ABS; Gillitzer and Kearns (2005), RBA Research Discussion Paper, Jarkko Jääskelä and Penelope Smith, Dec 2011.
The RBA has released an interesting discussion paper about Australia’s terms of trade, titled “Terms of Trade Shocks: What are They and What Do They Do?”
http://www.rba.gov.au/publications/rdp/2011/pdf/rdp2011-05.pdf
The paper describes and quantifies the macroeconomic effects of different types of terms of trade shocks and their effect on the Australian economy.
“One of the most significant influences on the Australian economy over the past decade has been the booming terms of trade which has risen by almost 80%. The terms of trade are currently around their highest level of the 140-year history of the series. The current boom is comparable in magnitude to the wool booms of the 1920s and the 1950s but has been sustained for much longer.”
Three types of terms of trade shocks are identified in the paper, based on their impact on commodity prices, global manufactured prices, and global economic activity. The first two shocks, a world demand shock and a commodity-market specific shock are fairly standard. We appear to be enjoying the third type of shock, “a globalisation shock”, that has resulted from the increasing importance of China, India and eastern Europe in the global economy. The globalisation shock is associated with a decline in manufactured prices, a rise in commodity prices, and an increase in global economic activity.
The main conclusion of the paper is that a higher terms of trade tends to be expansionary but is not necessarily inflationary; the floating exchange rate has provided an important buffer to the external shocks that move the terms of trade.
Editor’s warning: this article is most likely of interest to the economic policy wonks among us.
