The floating of the Australian dollar, 20 years ago this week, was one of the most significant economic policy decisions in Australia’s history. As Paul Kelly wrote in his survey of the 1980s, The End of Certainty, the float (and the financial deregulation of which it was a central element) were "arguably the greatest blow struck against the protectionist, introverted, regulatory apparatus" established in the early years of Australia’s existence as an independent nation.
That apparatus was largely responsible for the deterioration in Australia’s economic performance, and for the associated decline in Australians’ standard of living relative to that of citizens of other Western nations, over the 45 years following the end of World War II. The float helped to create the environment in which dismantling the system of "protection all round" became politically possible.
As a result of the float, the value of the Australian dollar relative to other currencies became determined by the collective judgement of thousands of Australian and overseas investors – who stood to gain or lose from their judgements – rather than by the whims and preferences of politicians and bureaucrats.
For the first five years after the float, there was a remarkably strong correlation between the exchange rate and the level of consumer confidence, as ordinary Australians interpreted the (for the most part downward) movements in the dollar’s value as an adverse reflection on the performance of, and prospects for, the Australian economy. The exchange rate thus attracted political significance, as Ministers in the Hawke government (and their counterparts in the Opposition) used it to build constituencies for further economic reform. The dollar’s sharp decline in the mid-1980s thus served as an important catalyst for the liberalisation of restrictions on foreign investment in Australia, for the first tentative steps away from automatic indexation of wages for movements in the CPI, and for the emphasis on moving the Federal Budget into surplus over the second half of the 1980s. By the late 1980s, when the A$ began rising again and consumer confidence no longer so closely tracked its movements, the bi-partisan commitment to economic reform had become firmly entrenched.
More broadly, the float contributed to the internationalisation of the Australian economy by facilitating, as a result of the improvement in international competitiveness flowing from the dollar’s mid-1980s decline, a significant increase in the share of exports in GDP; and, as a result of the removal of exchange controls, a significant increase in Australian investment overseas as well as in foreign investment in Australia. These developments in turn strengthened the basis of support for policies aimed at enhancing Australia’s competitive strengths, in particular trade liberalisation.
Finally, the float has had a lasting beneficial impact on the conduct of macro-economic policy in Australia. It eventually freed monetary policy from the obligation to support a pre-determined value of the exchange rate. The importance of this freedom took some time to become apparent, as monetary policy initially floundered around without any clear "anchor". But from the recession of the early 1990s Reserve Bank emerged with de facto control of what has become the most important instrument of economic policy, the cash rate, and a credible framework for implementing it, the inflation target.
And with the Reserve Bank’s credibility enhanced by its success in keeping inflation within the target range, the exchange rate has been able to play its textbook role of acting as a buffer against externally generated shocks, during the Asian crisis and again in the aftermath of the "tech wreck" and the subsequent downturn in the global economy.
In effect, the float has contributed to a shift in the balance of economic policy making power from Canberra to Sydney, and with it a (welcome) reduction in the scope for the requirements of the economic cycle to be subordinated to the dictates of the political cycle.
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