Prof. Warwick McKibbin has gone a bit rogue since leaving the RBA Board.
In May, he warned that too deep a rate cut would unleash an inflation shock:
Too deep a cut in interest rates will just bring down the currency and worsen inflation further and raise domestic demand even further unleashing an inflation shock
With the AUD ~3 cents stronger and the cash rate 75bps lower, he has tuned his focus on the AUD. Today he uses his 1988 paper to argue that the RBA should buy foreign assets to depress the value of the AUD:
If foreigners want to hold more Australian dollars in order to park these dollars in foreign exchange reserves and will not be using these dollars to buy Australian goods and services, then the best response is for the Reserve Bank to print more Australian dollars. These additional dollars should be sold to foreign central banks in return for foreign assets. The foreign assets would appear on the RBA balance sheet exactly balancing the increase in money supply. There would be no effect on the domestic economy from this global shock if the RBA undertook this transaction.
The reason the literature on optimal floats grew in the 1980s is that floating exchange rates were new. The reason the literature died is that floating exchange rates performed pretty well.
The floating AUD has served us very well – indeed, those involved in the long drudge of reform rate the rate floating of the AUD as the most important single step in economic policy taken in the post-War period.
Let us leave the pandora’s box of exchange rate intervention closed.