Alternative Measures of the Effects of Exchange Rate Movements on Competitiveness

In the past year there have been some sharp movements in exchange rates, involving substantial depreciation of a number of East␣ Asian currencies and an appreciation of the US dollar against other major currencies. The Australian dollar has declined against the US␣ dollar, but has appreciated substantially on average against the East Asian currencies. The economic turmoil in East Asia will affect other economies in two ways. First, some of the contraction of demand and growth in East Asia will tend to spill over to other countries that export into the region. Second, the exchange rate movements that have taken place will have potential implications for prices and the international competitiveness of countries that trade with East Asia. This article focuses on the second of these issues, with a particular emphasis on the divergence in exchange rate movements over the past year. The two standard indicators of the Australian dollar exchange rate are the bilateral rate against the US dollar and the trade-weighted index (TWI) (Graph 1). The simplest approach of focusing only on a single bilateral rate, such as the $US/$A rate, is often quite misleading. In the past year, the Australian dollar has depreciated against the US dollar by around 20 per cent, but this clearly overstates the extent of any overall depreciation because it is in large part a reflection of US dollar strength. The US dollar has been the strongest of the major world currencies over this period, rising in trade-weighted terms by over 10 per cent. In general, it is more useful to look at the exchange rate in terms of more broadly based measures that take a range of bilateral rates into account. The most commonly used measure, the TWI, has been relatively stable, with the depreciation against the US dollar (and, to a lesser extent, against other major currencies) being offset by large appreciations against the currencies of a number of important East␣ Asian trading partners. Other more specialised exchange-rate indices can also be constructed: for example, separate exportand import-weighted indices, or indices designed to reflect competition with third countries rather than just bilateral trade shares. In most circumstances, particularly