During the latter part of 2002 large areas of Australia have been affected by severe drought. In this paper, we examine the prospects for the Australian economy between 2001-02 and 2004-05, with particular emphasis on the implications of the drought for regions. Forecasts that take into account the drought and an assumed recovery are undertaken with the MONASH model. Year-on-year forecasts are provided for macro and micro variables at the national level. The paper then reports on simulations of the regional effects of the drought, undertaken with a new multiregional model, TERM. Detailed effects of the drought for the model's 45 regions are reported. The drought is estimated to lower 2002-03 GDP by 1.6 per cent and employment by 0.8 per cent. All mainland states are negatively affected. Eleven of the model's 45 regions are projected to have their GRPs lowered by more than 10 per cent by the drought, with a further seven regions being projected to have their GRPs lowered by between 5 and 10 per cent.