christopher kent : the resources boom and the australian dollar address by mr christopher kent, assistant governor ( economic ) of the reserve bank of australia, to the committee for economic development of australia ( ceda ) economic and political overview, sydney, 14 february 2014. * * * i thank jonathan hambur, daniel rees and michelle wright for assistance in preparing these remarks. i would like to thank ceda for the invitation to speak here today. i thought i would take the opportunity to talk to you about the implications of the resources boom for the australian dollar. the past decade saw the australian dollar appreciate by around 50 per cent in tradeweighted terms ( graph 1 ). 1 the appreciation was an important means by which the economy was able to adjust to the historic increase in commodity prices and the unprecedented investment boom in the resources sector. 2 even though there was a significant increase in incomes and domestic demand over a number of years, average inflation over the past decade has remained within the target. also, growth has generally not been too far from trend. this is all the more significant in light of the substantial swings in the macroeconomy that were all too common during earlier commodity booms. 3 the high nominal exchange rate helped to facilitate the reallocation of labour and capital across industries. while this has made conditions difficult in some industries, the appreciation, in combination with a relatively flexible labour market and low and stable inflation expectations, meant that high demand for labour in the resources sector did not spill over to a broad - based increase in wage inflation. 4 so the high level of the exchange rate was helpful for the economy as a whole. but now that the terms of trade are in decline and the resources boom has begun the transition from the investment to the production phase, lower levels of the exchange rate will assist in achieving balanced growth in the economy. while my focus today is on the relationship between the resources boom and the exchange rate, at the outset i should note that this is only one factor – albeit a very important one – influencing the exchange rate. i will touch on some of the other factors later in my discussion. from the mid 1960s to the mid 1970s, the nominal twi appreciated by about 35 per cent. prior to that, there was a substantial appreciation after world war i, when the australian pound was fixed to the british pound, which in turn had returned to the gold standard at its pre - wwi rate. for example, see stevens g ( 2011 ), “ the resources

warm and not too cold, and stable disequilibrium. this is an episode in our history where variability of growth in real output has declined along with the variability in inflation. along the way, imbalances in the global economy began to build up. the imbalances manifested themselves in huge trade surpluses and an accumulation of foreign exchange reserves in the countries which relied on export - oriented growth – including those in the asian region. they were reflected in the dollar revenue which was subsequently reinvested in us financial markets – which in turn helped to finance the us saving deficit, permitting these imbalances to remain uncorrected for a prolonged period of time. and as a result, asset price bubbles were also allowed to persist for a prolonged period as well. all was well as long as everyone continued to grow. however, as emerging markets opened up, global demand, and particularly demand from growing economies like china and india, drove up the prices of oil and other global commodities. many economists began to predict a structural shift in global demand and changing dynamics of global inflation which would effect domestic prices and make inflation higher and more persistent. 3. coping with the global financial crisis at the same time, problems were brewing on the financial side in the advanced economies. i will not lay out the causes of the financial crisis here, as that has been discussed widely elsewhere. in a nutshell, the slowdown in the us housing market, coupled with a mix of troubled banking practices, regulatory blind spots, and absolute faith in the market mechanism, among other things, led to a financial crisis in advanced economies. but the important point here is that financial innovations, coupled with technological advances in communications, helped to link financial markets across the globe. this globalization of financial services allowed the collapse of major financial centers to spread to the rest of the globe so efficiently. in fact, these very financial instruments which had been earlier used to diversify risks turned out to be the very means for spreading contagion. the spread of the impact of the financial crisis onto the global real economy through the trade channel changed the world ’ s economic outlook rapidly and dramatically. this had a drastic impact on the inflation outlook, and the threat of inflation has rapidly shifted to one of possible deflation. at the same time, central banks are running out of traditional monetary policy ammunition to fight the slowdown in growth and potential deflation – namely cutting interest rates. given the increasing influence of external factors on global inflation dynamics,