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The mysteries of the floating dollar

By Peter Jonson - posted Thursday, 5 April 2012


Such opposition in December 1983 might (I speculate) have been the response of an institution overly conditioned to oppose the government of the day. Treasury was used to fighting economic nonsense-witness the Khemlani affair during the Whitlam government. Treasury then rightly objected to the policy agenda being hijacked by enthusiastic and incompetent amateurs. And assuming Treasury was the reforming institution Stone says it was, how do we explain the Fraser years, which are famous for their lack of economic reform? Perhaps by the time a competent Labor government arrived, Treasury's senior men were unused to proposing specific reforms, or even locked into opposition to reform proposals suggested by the government or its prime minister.

(After writing this paragraph I came across David Kemp's 2006 paper, "Advisors and Decisions 1976". Dr Kemp says, "At the core of the [Fraser] government there was an epic battle between the Prime Minister and the government's senior advisors in the Treasury, the Department of Foreign Affairs, and the Department of the Prime Minister and Cabinet." In discussing economic policy and the devaluation of 1976, Kemp says: "This refusal [to draft a statement on the economy] was essentially a strike that threatened to remove the government's capacity to defend its position." It is also interesting to learn from Dr Kemp that in mid-October 1976, Friedrich Hayek visited the Prime Minister and "opened the conversation with the suggestion that the exchange rate should be allowed to float".)

In my book Great Crises of Capitalism I suggest that opposition to the float by the Secretary of the Treasury in 1983 may have been based on the analytic point that, with a floating exchange rate, monetary policy is relatively more important than fiscal policy, whereas with a fixed rate it is the other way round. Perhaps (I speculated) Stone believed that loss of international reserves provided a far bigger stick with which to beat a profligate government than a falling exchange rate.

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In fact, another mystery is that following the float it took the best part of a decade for monetary policy to be used strongly enough to beat inflation, and then it came in the form of the "recession we had to have" to quote Paul Keating's typically memorable description. At the time of the earlier "banana republic" crisis, legend has it that Keating achieved serious cuts to government spending by counting out the score for the Expenditure Review Committee as the currency sank inexorably.

I should add that the interest rate cuts in 1987 and 1988, which were attributed to me as "principal architect" by Paul Keating, were in fact against my advice at the time. I was one of few on the official team who did not see the 1987 share market crash as likely to cause an economic slump, and I was concerned at the inflationary pressures. At each meeting of the board I recommended rate hikes, messages apparently agreed to by the board, before stepping down as head of research in early 1988. Given that the easing of monetary policy at that time, against my advice, is now seen as a major mistake, this is yet another mystery surrounding the floating of the dollar, in this case concerning the delayed achievement of low inflation.

Almost thirty years on, we have come to see a floating exchange rate as more than a necessary policy to beat inflation (but not sufficient unless accompanied by disciplined monetary policy). Now that the debate has been won by solid and painful experience, a floating currency is also seen as an automatic stabiliser, depreciation supporting activity when the economy is struggling and appreciation helping constrain inflation when the economy is doing well. The current mining boom with strong commodity prices is testing this view due to the pressure from a high exchange rate on non-mining industries, but the general point remains valid.

In summary, there was at least a decade of research and careful analysis behind the Reserve Bank's position in early 1983. Equally, close interaction with markets provided direct evidence of the futility of fixed exchange rates (always forced to flex when external or domestic economic conditions change sufficiently) or gradual "crawls" to what politicians or officials thought was a better position. More generally, I recall the decision to float the Australian dollar as: (a) way overdue; (b) solidly backed by economic theory and research specifically applied to the Australian economy and its markets; and (c) reinforced by a number of points of "political economy". I certainly agree with John Stone's May 1984 judgment that the float decision was "the most important single step in economic policy to be taken by any Australian government in the post-war period". Maybe a marginally better time and circumstance could have been found, but often a missed tide never returns.

 

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P.D. Jonson adds:

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.



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About the Author

Peter Jonson is a professional director and economist. He is a director of National Forum, Chair of the Federal Govenment's CRC Committee, Founding Chair of Australian Institute for Commercialisation (2002-2007), and Chair Emeritus of the Melbourne Institute Advisory Board. He is a Fellow of the Academy of the Social Sciences in Australia and a Fellow of the Australian Institute of Company Directors. Peter is founder and editor of Henrythornton.com, a virtual guide to economics, politics and investments.

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