As the great bard put it, "There is a tide in the affairs of men, which, taken at the flood, leads on to fortune …" The tide was taken in 1983 and the floating of the Australian dollar was a reform that helped make Australia one of the most successful nations.
Another wise saying reminds us that success has many fathers and failure is a bastard. This is indeed the situation with respect to the floating of the Australian dollar. The principal candidates are Prime Minister Bob Hawke and Treasurer Paul Keating, both of whom played the roles appropriate to their position in an elected, reformist government. Advising the two leading politicians were their private advisers, among whom Professor Ross Garnaut is said to have been especially influential, the Treasury and its mercurial secretary John Stone, and the Reserve Bank of Australia and its governor Bob Johnston.
In my opinion, all of these people and the two great public institutions involved played their part. Bob Hawke had studied economics at Oxford University, had served on the board of the Reserve Bank and organised a successful National Economic Summit early in his prime ministership. Paul Keating had his own qualifications from the school of hard knocks, a description he offered at the time of our first meeting, and great political courage. Bob Johnston had co-ordinated the Reserve Bank's contributions to the work of the Campbell committee and was keenly interested in better communication between the Reserve Bank and the Australian public. The intellectually formidable Secretary of Treasury, John Stone, had for many years worked at senior levels in Treasury, promoting good sense in economic policy and favouring deregulation over regulation in Treasury's policy advice and public utterances.
Floating the Australian dollar was a team effort, but there are various mysteries, including the mystery of the missing cabinet papers. My aim is to tell the story of the float from an RBA perspective and to address several greater and lesser mysteries.
I should state at the outset that I am relying on what I regard as a sharp memory as an adviser to the governor of the Reserve Bank, as a participant in what was a major research effort within the Reserve Bank, and first-hand experience of exchange rate management including the virtual floating of the forward rate. I have also where possible checked my memory of events against those of key Reserve Bank and Treasury players. I benefited from reading the transcript of an interview of John Phillips, former deputy governor of the Reserve Bank, recorded by Frank Heimans and held in the National Library of Australia.
The Reserve Bank was uniquely placed to understand the market dynamics that effectively demanded the adoption of a floating exchange rate, and the theoretical points that argued for the same outcome. The Reserve Bank contained within its senior ranks men with a strong respect for the lessons of history and the damage done by inappropriate policy settings, including the major error of a fixed but variable exchange rate when global inflation took off in the late 1960s.
I arrived at the Reserve Bank in early 1972 on the bottom rank of graduate entry. It quickly became clear that people in the Research Department almost to a man and woman believed that the financial system needed to be deregulated, with credit for this going mostly to the then Head of Research (equivalent to the current title of Assistant Governor, Economic), Austin Holmes, who was strongly supported by his then Deputy, Don Sanders, later deputy governor and then CEO of the Commonwealth Bank. John Phillips, who was also to play a vital role as the master of the markets in 1983, was about to return from Secretary's department to PNG department to hand it over to the newly created Bank of PNG.
Austin Holmes was a larger-than-life and much loved figure who received his economics training at Cambridge University, where he formed a strong friendship with Harry Johnson, then a young lecturer. Harry went on to be one of the world's top monetary economists, with joint professorial appointments at the University of Chicago and the London School of Economics.
Holmes was a free thinker with a sound knowledge of modern monetary economics. He worried about the damage wrought by inflation and argued for the orthodox position that avoiding inflation in an inflationary world, as it was becoming in the early 1970s, required a disciplined monetary policy including a floating exchange rate. As a young newcomer, I had the opportunity to ask the then deputy governor Harry (later governor Sir Harold) Knight whether he believed Australia should have a floating exchange rate. Harry replied that, like Saint Augustine, he wished to be made pure, but not yet. He gave this same reply when asked years later by the Campbell committee. This committee eventually recommended an exchange rate "determined in the market", demonstrating that the case for such a reform was well accepted outside official circles.
When the Campbell committee was deliberating there was a certain amount of internal tension in the Reserve Bank about this matter. I was selected as part of a group of officers headed by Bob Johnston, then the Bank's secretary and in charge of dealing with the Campbell committee, to answer questions asked by that committee. The night before this group was to appear before the committee we were told by Bob Johnston that we had to stick to the (Augustinian) party line on the currency regime. I objected and was robustly ticked off, but then next morning was told that I was free to express my personal view.
As part of my early research I analysed the effects of the global upsurge of inflation on Australia's inflation using a modified version of the Bank's RBI (econometric) model of the economy. The results of this exercise showed that the rise in Australia's inflation was largely due to global inflation, that it was imported, although reinforced by the Whitlam government's fiscal and wage policies. This was controversial at the time, but I was allowed to present this result at academic conferences and seminars despite bureaucratic discomfort due to the fact that Treasury argued at the time that Australia's inflation was largely due to wage pressure. Three years later I was told by Treasury's Chris Higgins that Treasury had come to believe that I had got this matter right.
I later developed a more sophisticated model (called RBII) of the Australian economy and used it to demonstrate in refereed journals the sort of conclusions that Austin Holmes, Don Sanders and other senior officers believed to be true, based on their knowledge of monetary economics. A version of this model was later used to convince Treasurer Keating to change course at the time of his "banana republic" outburst in 1986. Projections for five years ahead showed a jump in Australia's international debt (relative to GDP) and a large currency devaluation. This projected debt explosion would only be stabilised, the model and my advice suggested, if fiscal policy was tightened substantially, real wages were cut and monetary policy was tightened. This of course is a different story, except to demonstrate that the Reserve Bank took seriously its economic theory and research based on that theory. This is an example of a case in which the Reserve Bank led a debate that could have been, arguably should have been, led by Treasury. It also earned me the Treasurer's enmity and led fairly directly to the end of my hitherto promising career as a central banker.
In preparing this paper I have consulted several former colleagues, including retired senior Reserve Bank officials, but also former Treasury officials and political staffers. I have benefited in many ways from John Stone, "Floating the Dollar: Fact and Fiction",Quadrant, January-February 2012. My essay "On the Edge of Chaos" contains a more personal account of my involvement in various matters, including the float of the dollar, during my career at the Reserve Bank (available here...).
This article was first publishedin Quadrant.