A review is presented of the aerosol-climate interaction with specific focus on the Australian region. The uncertainties associated with this interaction are much larger than those associated with greenhouse gases or other forcing agents, and are currently a major obstacle in climate-change research. However, new research suggests that aerosol effects are of comparable importance to greenhouse gases as a driver of recent climate trends in the Southern Hemisphere, including Australia. A significant new result from climate modelling is that anthropogenic aerosol over Asia affects meridional temperature gradients and atmospheric circulation, and may have caused an increase in rainfall over north-western Australia. Global ocean circulation provides another mechanism whereby aerosol changes in the Northern Hemisphere can affect climate in the Southern Hemisphere, suggesting an urgent need for further targeted studies using coupled ocean-atmosphere global climate models. To better model climate variability and climate change in the Australian region, more research is needed into the sources of aerosol and their precursors, their atmospheric distributions and transformations, and how to incorporate these processes robustly in global climate models (GCMs). The following priorities are suggested for further research in Australia linking aerosol observations and modelling: natural aerosol over the Southern Ocean, tropical biomass-burning aerosol in Indonesia and Australia, secondary organic aerosol (SOA) from volatile organic compounds (VOCs), wind-blown dust and modulation of rainfall by anthropogenic aerosol.