Demographic transition and the real exchange rate in Australia: An empirical investigation

Abstract

This article utilizes the empirical findings that age structure of the population affects saving, investment and capital flow and hypothesizes that age structure influences the real exchange rate. Based on this link, an empirical model is specified for Australia and estimated with annual data for the period 1970–2011. An autoregressive distributed lag model of cointegration indicates that Australia's real exchange rate is cointegrated with its productivity differential and the relative share of young dependents (0–14 years) in the population. Long-run estimates show that young cohort has an appreciating influence on the real exchange rate. Also, the short-run adjustment is substantial, with more than 65% of the disequilibrium corrected in a year.

Keywords:

• demographic transition
• real exchange rate
• saving
• life cycle hypothesis
• ARDL model

Acknowledgements

The authors are grateful to the anonymous referees for constructive and useful comments which tremendously improve the quality and presentation of this paper. However, usual disclaimer applies.

Notes

1. Intergenerational Report (2010).

2. The terms of trade has also been mentioned as an important determinant of the exchange rate, but this influence is thought to be transitory depending on the world commodity price cycle. As such, the terms of trade should not influence the long-run real exchange rate as modelled in this paper.

3. Table A3 in the Appendix shows that demographic variables are highly correlated (correlation coefficients are above 0.91). To avoid multi-collinearity at a time one demographic variable is included in the equation.