Exchange Rates and Prices of Australian Manufactured Exports By Jayant Menon C o n t e n t s: I. Introduction. - II. Analytical Framework. -III. Results. - IV. Con- clusion. - Appendix. I. Introduction F oreign exchange markets around the world have been charac- terized by a considerable amount of variability since the advent of floating exchange rates after the breakdown of the Bretton Woods system more than a decade ago. Lately, it has not been uncom- mon to find bilateral exchange rates displaying wide fluctuations on a month-to-month or even day-to-day basis. The Australian dollar (AUD) has not been an exception. The observed turbulence in ex- change rates has brought to the forefront the relationship between exchange rate movements and the prices of traded goods. This rela- tionship, which has been termed "pass-through", lies at the very heart of current debate on the effectiveness of exchange rate policy in bring- ing about current account adjustment. For exports, exchange rate pass-through refers to the degree to which exchange rate changes affect prices of traded goods measured in foreign currency terms.1 There has been a tremendous interest shown in the pass-through relationship of late, sparked probably by the failure of US import Remark: I am grateful to P.B. Dixon for constructive comments, and P. Athukorala for assistance in data handling and comments on this paper. I remain solely responsible for the final product. 1 Note that pass-through is measured as the percentage change in the selling price of exports/imports divided by the percentage change in the exchange rate. The way in which pass-through is defined may result in some confusion between the expected out- comes for pass-through on the export and the import fide. To clear up any confusion, let us consider the case where the small country assumption holds for Australia. On the export side, it is the prices received by Australian exporters in AUDs that must adjust to the exchange rate change, so that the selling price of exports in foreign currency remains unchanged. Pass-through on exports is said to be zero. On the import side, we would expect the selling prices of imports in AUDs to fully reflect the exchange rate change, and in this instance pass-through is said to be complete or 100 per cent.