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The real effective value of the Australian dollar declined sharply between early 1985 and September 1986. 'Market fundamentals' associated with the deterioration in Australia's terms of trade and current account, and rising foreign debt levels are the commonly cited explanation for the decline. However, several other shorter term influences may have also contributed. Theoretical and empirical analysis indicates that market fundamentals might explain, at most, 20 percentage points of the 37 per cent decline in the rate over this period. Thus, a significant real appreciation would be expected over the medium term prior to, and quite independently of, any recovery in Australia's terms of trade in general or in world farm commodity prices in particular.


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