Variables Included in the Trade Models

To empirically investigate the relationship between real exchange rate volatility and real Australian export volumes to US/ Japan, six economic variables are needed for each country. As a standard practise in applied econometrics, all series are log-transformed.¹⁴

For the empirical analysis on trade, data from the post float period, from 1988:1 to 2005:1 is used. This study avoids using the first few quarters that come after the floating of the exchange rate in 1983 in order to accurately test for the effects of the real exchange rate

14 The log-log model enables each slope coefficient to be interpreted as the elasticity of the dependent variable with respect to the explanatory variable.

volatility after the initial structural adjustment effects of the float on export volumes. As mentioned by Pozo (1992), the start of the floating exchange rate regime is usually characterised by an explosion of volatility. Moreover, some of the data series are not available prior to 1988.

The definitions and construction of these economic variables are discussed as follows:

Real Australian export volumes to US/ Japan

(

)

Real export volume is defined as the value of real exports divided by the Australia’s export price index. However, as the export price index for Australia is not available, export unit values are used as a proxy instead.¹⁵

Real US/Japan Gross Domestic Product (GDP) index (1995=100)

(

)

Standard economic theory suggests that real income in the importing country is a major determinant of an exporting nation’s exports. In this study, the real GDP is used as a proxy for real income (Chowdhury 1993).

GDP is defined as the total value of final goods and services produced in an economy during a specified period, including any taxes and minus any subsidies not included in the value of production. In this case, real GDP is used so that the effects of inflation are accounted for to estimate the actual quantity of goods and services making up GDP. For the empirical analysis on trade, the real US/Japan GDP index is used instead, with reference year, 1995 = 100.

Relative price of imports of the US/Japan

(

)

The relative price of imports of the importing country is constructed as the ratio of Australia’s export price index to the importing country’s export price index. This is also a measure for competitiveness.

15 This has also been practised in Chowdhury (1993).

Bilateral Real Exchange Rate Volatility

( )

Firstly, the choice between using the real or nominal exchange rate in empirical analysis of this issue has been prominently discussed. Due to sticky prices, it has been argued that the real and nominal exchange rate volatilities should be the same in the short to medium run.

However, in the presence of high inflation, nominal exchange rate volatility is expected to be higher than real exchange rate volatility (Clark, P. et al. 2004). For this reason, the empirical analysis in this thesis will use measures of real exchange rate volatility.

The bilateral real exchange rate volatility is constructed using the standard ARCH/GARCH methodology.¹⁶ In order to construct the volatility variables, the bilateral real exchange rate has to be calculated. This can be defined as the product of the nominal exchange rate and relative price levels in each country. Thus, the USD/AUD real exchange rate can be defined as:

* p e p RER= ×

Where e is the USD/AUD nominal exchange rate, p and p* are the price levels in Australia and US respectively. Similarly, the YEN/AUD real exchange rate can be constructed.

It should be noted that in the context of this study, both the nominal and real exchange rates are expressed in a volume notation form. This implies that an appreciation of the exchange rate is equivalent to an increase in the exchange rate and a depreciation of the exchange rate is equivalent to a decrease in the exchange rate.

Threshold Indicator

(

)

The threshold indicator variable is essentially a dummy variable that is equivalent to one when the threshold level of real exchange rate volatility is exceeded. The methodology

16 This methodology is further elaborated upon in Chapter 5.

employed to obtain the value of the threshold )(τ level of real exchange rate volatility is further elaborated in Chapter 5. ¹⁷

Interaction

(

)

The interaction term in this study is the product of the bilateral real exchange rate volatility and threshold indicator. This term specifically measures the additional effect on exports due to real exchange rate volatility exceeding a threshold level.

Data Sources

All data sources for variables used directly or in the construction of other variables for the empirical study on trade are summarised in Table 2.1. Refer overleaf for Table 2.1.

17 Refer to chapter 5 for more information on the methodology behind obtaining an optimal threshold level.

Table 2.1: Data Sources for US/Japan Trade Models

Variable Data Source

Exports to US ($m) Australia Bureau of Statistics (ABS) Time Series Statistics Plus in dX Database

Exports to Japan ($m) ABS Time Series Statistics Plus in dX Database

Export unit values – Australia International Monetary Fund (IMF) – International Financial Statistics (IFS) database, available at

http://ifs.apdi.net/imf/logon.aspx

GDP Index – US ABS Time Series Statistics Plus in dX

Database

GDP Index – Japan ABS Time Series Statistics Plus in dX

Database Export price Index – US IFS database Export price Index – Japan IFS database

USD/AUD Nominal Exchange Rate RBA Bulletin Database in dX Database YEN/AUD Nominal Exchange Rate RBA Bulletin Database in dX Database

CPI – Australia TABLE C1. “CPI – All Items Total” (Base

year (1995=100) obtained from Ausstats database, cat. No. OECD (C) – Consumer Prices

CPI – US TABLE C1. “CPI – All Items Total” (Base

year (1995=100) obtained from Ausstats database, cat. No. OECD (C) – Consumer Prices

CPI – Japan TABLE C1. “CPI – All Items Total” (Base

year (1995=100) obtained from Ausstats, cat. No. OECD (C) – Consumer Prices