Against FX intervention

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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.


  1. You could make an argument for buying foreign bonds if we are talking monetary easing.

  2. Wouldn’t normally nitpick like this, but I think you mean ‘rogue’. Hope this doesn’t leave you red-faced :-)

    I don’t understand how McKibbin could say that this so-called global shock to our currency could and should be offset by direct intervention while also saying that monetary policy is too loose.

    1. Fixed now – thanks :)

      As for WM – i suppose he favors a lower FX higher rate mix. Better for manufacturers, worse for consumers… I do not like it myself.

      1. That could be one way to make some sense of his position (which still wouldn’t work because aggregate demand is aggregate demand) except for the fact that in the quote you reproduced above, the very transmission mechanism he cites for lower rates boosting inflation is a lower currency!

  3. “i suppose he favors a lower FX higher rate mix. Better for manufacturers, worse for consumers…”

    consumers would also like to keep their jobs if possible :)

    I have always thought that if the high AUD is really damaging the economy, then the AUD will come down. That the forex markets are working fine…. but now we had 100+ bps of rate cuts, commodity prices coming down significantly, and the AUD is till up there, exactly where it was 1 year ago. There must be a point where one says forex pricing is no longer working properly, due to the fact that. for instance, rates in other countries are exceptionally / abnormally / structurally low. One could argue these are not “normal” times. The Swiss have done it and they are in a situation similar to Australia.

  4. By the way, I keep reading that rate cuts bring down the currency… but that has not eventuated in the last 12 months… not unexpected when US, Europe and Japan are basically at zero already, China is pegged and Australia is at 3.5% with one of the last remaining AAA rating?

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