Measuring the Effects of Exchange Rate Changes on Investment in Australian Manufacturing Industry

Abstract

This paper uses an empirical framework derived from an optimising adjustment-cost model of investment to examine the relationship between exchange rates and investment in Australian manufacturing industry between 1988 and 2001. The results show that the response of investment to exchange rate changes varies with the external exposure of industry, positively with export share of sales and negatively with the share of imported inputs into production. Industry competitive structure, represented by markup of price over cost, interacts with external exposure so that lower levels of markup increase the responsiveness of investment to exchange rate changes. For Australian manufacturing industry, a 10% real appreciation of the Australian dollar (AUD) leads to an average 8.0% decrease in total investment through the export share channel over the period, and an average 3.8% increase in total investment through the imported input share channel, with most of the response occurring through investment in Equipment, Plant and Machinery.