Abstract-20161202


Abstract

This paper examines the macroeconomic effects of the unwinding of the carry trade in a nonlinear TVAR model using the example of the JPY/AUD carry trade and the Australian macroeconomy. The model endogenously detects regimes of low and high pressure on the carry trade. In the high pressure regime where it is likely for the carry trade to unwind, the fall in the relative Australian interest rate combined with a reduction in commodity price inflation leads the economy to favorably respond with the fall in commodity prices boosting Australian GDP growth. This result confirms that the unwinding of the carry trade and the subsequent stimulus to exports is beneficial to Australian growth when international financial markets are at their most stressed. The probability of regime change is extremely low. However, large shocks in the high pressure regime corresponds to a 30 percent probability of moving to a low pressure regime as the system corrects itself.