Movements in the terms of trade can have a significant impact on the Australian economy.

Upswings
in the terms of trade increase the real purchasing power of domestic output.
As the real exchange rate and the terms of trade tend to move closely together, further declines in
the terms of trade could also be accompanied by a further real depreciation. This increase in
competitiveness is important in facilitating the transition in the sectors that contribute to output
growth, as it promotes growth in the tradable sector outside of resources. A nominal depreciation is
one way such an increase in competitiveness may occur; higher productivity growth and real wage
restraint would also support Australias competitiveness. In coming years, measured national
productivity will be boosted by the growth of production in the resources sector; however,
productivity growth in the rest of the tradable sector will also be of importance in increasing
Australias competitiveness
The Australian dollar has fallen due to both US dollar strength and further declines in commodity
prices. Assuming the lower level of the currency is sustained, it should be expected to support a
further lift in local demand over time, as it helps to improve competitiveness and supports local
incomes. At the same time, the lower currency will add upside risk to the inflation outlook, which
supports the case for lifting interest rates, at some point, particularly given that the housing market
is continuing to show signs of exuberance.
However, the sharp drop in iron ore and coal prices means that average export prices could be 8 to
10 per cent lower. Treasury estimates that a fall in export prices that is four percentage points
greater than expected would translate into a $2.6bn increase in this years deficit and a $5.4bn
increase next year, mostly a result of weaker company tax.
Over that same period, Australia's terms of trade has continued to decline and some key commodity
prices for Australia, most notably the iron ore price, have declined considerably