key determinants would suggest. during such episodes, if we assume that history is a good guide, and that we have measures of the right set of determinants, this in turn implies the potential for a correction in the exchange rate sometime in the future. the questions though are whether history is a good guide, have we given appropriate weight to each of the determinants, and when ( if at all ) might such a correction occur? the effect of the resources boom the terms of trade – the ratio of the price of our exports to imports – have always been an important determinant of our exchange rate. the emergence of china onto the global economic stage at the turn of the millennium ( after it joined the world trade organization ) led to a large, and largely unanticipated, rise in global commodity prices and saw the near doubling of australia ’ s terms of trade between 2003 and 2011 ( graph 2 ). graph 2 other than in a smooth fashion to account for any interest rate differential. see sarno l and m taylor ( 2002 ), the economics of exchange rates, cambridge university press, cambridge uk. bis central bankers ’ speeches the gradual realisation that the world was willing to pay a lot more for the commodities we had in abundance, and that this was likely to be true for some time, led to a significant increase in the demand for australian assets tied to the production of commodities. this reflected a significant increase in the expected return to capital in the resources sector. there was also an increase in the demand for australian labour and materials, to help build and then operate the new extraction, production and transport facilities that have been, and are still being, put in place in the resources sector. these developments implied a significant increase in the demand for australian dollars and hence led to an appreciation of the exchange rate. we can trace out the sources of the additional demand in terms of the three overlapping phases of the resources boom as follows : ( i ) during the first phase – the boom in the terms of trade – we see a price effect. higher commodity prices lead to more export revenue. part of this revenue accrues as profits to australian owners of existing resource and resource - related companies, wages for workers at these companies and taxes for australian state and federal governments. also, foreigners wanting to buy existing australian resource assets add to the demand for australian dollars for a time. ( ii ) during the investment phase of the boom, funds from offshore owners are used to pay

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