Murnane was born in Coburg, Melbourne, and has almost never left the state of Victoria. Parts of his childhood were spent in Bendigo and the Western District. In 1956 he matriculated from De La Salle College Malvern.

Murnane briefly trained for the Roman Catholic priesthood in 1957. He abandoned this path, however, instead becoming a teacher in primary schools (from 1960 to 1968), and at the Victoria Racing Club's Apprentice Jockeys' School. He received a Bachelor of Arts from the University of Melbourne in 1969, then worked in the Victorian Education Department until 1973. From 1980 he began to teach creative writing at various tertiary institutions.

In 1969 Murnane moved to the Melbourne suburb of Macleod, where he has since lived.

He married in 1966 and has three sons.

Murnane's first two books, Tamarisk Row (1974) and A Lifetime on Clouds (1976), seem to be semi-autobiographical accounts of his childhood and adolescence. Both are composed largely of very long but utterly grammatical sentences.

In 1982, he attained his mature style with The Plains, a short novel about a young filmmaker who travels to a fictive country far within Australia, where his failure to make a film is perhaps his most profound achievement. The novel is both a metaphysical parable about appearance and reality, and a parodic examination of traditions and cultural horizons. The novel depicts an abstracted Australia, akin to something out of mythology or fable. The novel was followed by: Landscape With Landscape (1985), Inland (1988), Velvet Waters (1990), and Emerald Blue (1995). A book of essays, Invisible Yet Enduring Lilacs, appeared in 2005, and a new work of fiction, Barley Patch, was released in 2009. All of these books are concerned with the relation between memory, image, and landscape, and frequently with the relation between fiction and non-fiction.

Murnane is mainly known within Australia. A seminar was held on his work at the University of Newcastle in 2001. Murnane does, however, also have a following in other countries, especially Sweden and the United States, where The Plains was published in 1985 and reprinted in 2004.

Murnane is an avid follower of horse racing, which often serves as a metaphor in his work. A documentary, Words and Silk — The Real and Imaginary Worlds of Gerald Murnane (1989), directed by Philip Tyndall, examined Murnane's childhood, work, approach to the craft of writing, and interest in horseracing.

He also taught himself to read Hungarian, which he continues to do.