Remembering Bob Johnston and the 40th anniversary of the float
Plus, Jonathan Kearns makes the case for RBA reform
Former RBA Governor Bob Johnston died on 20 March 2023 at the age of 98. Bob served as Governor from 1982 to 1989 during a pivotal period in Australia’s economic history. In particular, Johnston was a key advocate of Australia moving to a floating exchange rate regime, not least over the then opposition of Treasury. The 9th of December this year will mark the 40th anniversary of the Friday afternoon press conference announcing the float (pictured above, Bob on the right of then Treasurer Keating). By the morning of Monday 12 March 1983, Australia’s exchange rate was market-determined.
In his biography of former Treasurer Paul Keating, Troy Bramston relates a March 1983 meeting between Keating and Johnston in which Keating pressed Johnston for his personal view on the existing managed exchange rate. Johnston told Keating, ‘I think it is a waste of time, really, what we are doing. We are a big enough economy now and strong enough on the monetary front for the rate to set itself’ (p. 197).
Together with the liberalisation of the capital account and the deregulation of interest rates, the floating of the dollar transformed the Australian economy. Before December 1983, the exchange rate was the tail that wagged the economy. Economic shocks that did not lead to an adjustment in the officially determined exchange rate had to be accommodated through adjustments in the domestic economy.
Milton Friedman made the intellectual case for a floating exchange rate regime as early as 1953. Friedman’s logic was compelling. A floating exchange rate would allow the economy to accommodate a wide range of external and internal economic shocks through the adjustment of a single relative price, rather than thousands of domestic prices.
A group of economists and policy practioners met in Burgenstock, Switzerland in 1969 to further develop the intellectual case for floating exchange rates in anticipation of the demise of the Bretton Woods system, which many of them saw as a profound threat to global free trade. The current account and other macroeconomic imbalances that built up behind fixed exchange rates led governments to pursue protectionist policies. A very young Wolfgang Kasper was at Burgenstock and a few years ago he shared with me the 9mm home movie he shot there, with its roll call of famous economists. I have never been able to convince him to share the film more widely, but I got Wolfgang to write about the conference for Policy. I would link, but the CIS website is completely borked these days. Remarkably, the conference papers are still in print.
By the end of 1973, Bretton Woods was history, but Australia persisted with its managed exchange rate. As another former Governor Glenn Stevens observed on the occasion of the 30th anniversary of the float, by 1983 ‘we had tried just about all the currency arrangements that were known to human kind’ except a market-determined one.
Most managed exchange rate regimes eventually fail. Today, the decision to float the dollar is portrayed as an act of policy heroism, which it was. But like many other countries, Australia was also forced to float by external pressures. As Bob Johnston later described it, ‘we didn’t make a formal decision to float until the death knock.’ Foreign capital inflows driven by speculation about yet another official revaluation of the exchange rate had undermined the Reserve Bank’s ability to control the domestic money supply, forcing the Hawke government’s hand.
The most significant implication of the float was that it allowed the Reserve Bank to conduct an independent monetary policy better suited to the domestic economy rather than one subordinated to the level of the official exchange rate.
Unfortunately, some of the potential benefits from an independent monetary policy were lost in the first 10 years of the float by the Reserve Bank’s failure to focus its monetary policy on the goal of price stability. The New Zealand experiment with inflation targeting did not begin until 1990. It was not until the onset of informal inflation targeting from 1993 and the adoption of an explicit inflation target in August 1996 that the Australian economy realised the benefits of an independent monetary policy focused on controlling inflation.
The floating of the exchange rate and the adoption of inflation targeting by the central bank also had radical, although still widely misunderstood, implications for the efficacy of fiscal policy. Government borrowing, rather than driving up domestic interest rates, now sees an increase in foreign capital inflows and an appreciation in the Australian dollar. The corollary of these capital inflows is a widening in the current account deficit and a smaller contribution to economic growth from net exports.
This crowding-out of government spending via the exchange rate and net exports can be reduced to the extent that private saving rises to offset increased government borrowing in anticipation of higher future tax burdens. Empirical estimates suggest that changes in private saving offset about half of any change in government saving. Yet this Ricardian offset is itself a hurdle for any discretionary fiscal policy that is meant to stimulate the economy through increased private consumption.
The other significant hurdle to the effectiveness of discretionary fiscal policy under a floating exchange rate is the Reserve Bank’s monetary policy. With monetary policy already given the task of managing aggregate demand, discretionary fiscal policy is subject to monetary offset. As Scott Sumner has argued, ‘estimates of fiscal multipliers become little more than forecasts of central bank incompetence’ when the central bank targets aggregate demand.
I only ever got to meet Bob once. In 2013, I was invited to speak on monetary policy to a small group that met regularly but informally over lunch at the Royal Automobile Club in Sydney.