Is Australian dollar is substantially overvalued?
No.
As we know, the BMI is based upon the price of a Big Mac in one country relative to another country, and comparing that with their exchange rate.
However, is the BMI a reliable method? It has a major flaw; that of which it does not account for non-tradable goods. The index assumption that the costs of the goods are the same and purchasing power parity would hold, but that is not always the case. The BMI fails to account for non-tradable goods, such as tax, transaction costs, wages and rent. Even if the prices of tradable goods are said to be equalised via arbitrage, they are still subject to regulations, subsidies and trade barriers that might warp the costs. This biases can distort the perceived valuation.

Another point that we shall look at would be in the following graph of the exchange rate within the last 10 years. As we can see, there has been an upward trend barring the financial crisis. This might point to the fact that the adjusted BMI that is using past data is might be biased towards a lower relative PPP, and does not account for the sustained growth trend that we have experienced. A new valuation of relative PPP should be considered, considering that Australia’s core commodities market is still going relative strong, despite China’s growth slowdown. <http://www.abc.net.au/lateline/content/2012/s3447302.htm> One could argue that the USD, having being shaken by the financial crisis, would be weak. As the AUD recovered faster and stronger than the USD, this might point to the assumption that the AUD is overvalued when compared to the USD, when it might the USD that is weak.

The RBA’s official stance on this matter is that the AUD is NOT overvalued. In a statement by the Reserve Bank Deputy Governor Doctor Philip Lowe, says that Australia’s GDP growth, inflation, interest rates and unemployment are all within their expected range, and that our low unemployment rate, which has remained below 5.5 per cent for the last two years, that indicates the Australian dollar is not over-valued.
"If the unemployment rate were to rise persistently, it might suggest that the contractionary effect of the high exchange rate was more than offsetting the expansionary effect of the investment boom in the terms of trade," he said.
"If this were to turn out to be the case, monetary policy would have the flexibility to respond provided that the inflation outlook remained benign."
What this means is that the Reserve Bank was quite comfortable with the level of the dollar and interest rates, and will not intervene unless unemployment climbs noticeably.
The Aussie dollar has held up reasonably well against bouts of risk aversion this year and attractive interest rates, a rising terms of trade and firm underlying economic fundamentals continue to spur demand for the Aussie.