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Cross-posted with permission from Interest.co.nz.
By Alex Tarrant
Australian economist Warwick McKibbin says he was surprised by the reaction to an opinion piece arguing the Reserve Bank of Australia could take upward pressure off the currency by printing Australian dollars and buying foreign exchange to offset foreign central bank purchases of the currency.
Speaking to interest.co.nz while in Wellington this week, McKibbin, a former RBA board member, said his comments had been misinterpreted by his critics, as he was not suggesting a peg of the Australian dollar, and neither had he claimed the plan was to lower the currency.
Writing in the Australian Financial Review earlier this month, McKibbin argued that allowing a pure float of the currency was not always optimal, especially if a central bank knew the nature of one of the shocks driving the exchange rate.
McKibbin noted a particular shock currently driving the Australian dollar higher was foreign central banks increasing their holdings of Australian dollars.
“This is a pure portfolio shock generated in the financial market,” McKibbin wrote.
“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,” he said.
“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.”
Other Australian economists jumped on McKibbin’s comments, suggesting speculators like George Soros, who famously bet against the Bank of England’s peg in the early 1990s, might do the same to the RBA.
While in Wellington to speak to the New Zealand Institute of Economic Research’s AGM, McKibbin told interest.co.nz the idea of never intervening in the market needed to be reviewed, especially if authorities knew the extent of a certain shock affecting the core structure of that market.
“My basic premise is it’s always a good idea to just let the exchange rate float,” McKibbin said.
“However if a certain shock could be identified, sometimes it was better to offset that shock directly. In broad terms, if you know where the distortion is, it’s better to deal directly with the distortion in the market than to actually do something else to try and offset the distortion,” he said.
McKibbin said he had been very precise in his writing.
“If [foreign central banks are] holding cash – most central banks don’t – but if they’re holding cash, or currency, then you should be just providing the currency. You should be doing that either directly to the central bank, or if they’re in the market, what you can do is provide the cash. You buy the foreign exchange, put it on the balance sheet of [your] central bank and then increase the money supply,” he said.
“But that increase in the money supply doesn’t have any domestic impacts because the increase has all gone into foreign ownership.That way you can intervene and offset the shock.”
His argument was “totally different” to reacting to a change in the exchange rate driven by commodity prices, better technology, or changes in trade flows.
“Let the market adjust, and let the exchange rate do it, rather than the price level,” McKibbin said of those types of shock.
‘It might not lower the A$’
McKibbin said the exchange rate may not move at all under his approach, which was to take some upward pressure off the currency.
“I’m not even targeting any exchange rate [level]. My proposal was, just shift your foreign exchange reserves on the balance sheet of the central bank to offset the shock,” he said.
McKibbin accepted there were risks involved.
“Because you are accumulating foreign assets, and if you are accumulating euros, and you think the euro’s going to collapse then you’ve got a bit of a change in risk,” he said.
“So it’s not completely risk-free, but the point was firstly to get people to think about…when you’re looking at a market-based system, maybe you should think through this idea that you should never intervene in any market.
“Because in most markets there’s always some reason to intervene if in fact there’s a breakdown of the core structure of the market,” he said.
McKibbin said it was the reaction to the article he didn’t expect.
“[To] even question the pure float seemed to be heresy. But again, there’s a lot of literature on leaning against the wind in currency markets, and if everything works perfectly then you never need to worry,” he said.
“But if you have a world of imperfections, which we do, then you’ve got to be at least having the debate on when is the best time to intervene in the market.”
In response to criticism that it would put the RBA up for a speculative attack by other traders betting against it, McKibbin said his plan did not involve any exchange rate pegging.
“I think it shows just the lack of understanding of firstly what I said. That’s why I wrote the AFR article, to make it precisely [clear about] the particular set of circumstances you can make an argument,” he said.
“But a lot of people who responded didn’t respond to what I said, they responded to what they thought I said.”
“It shows you just how much ideology there is out there, and occasionally it’s a good idea to think, rather than speak.”
Never said ‘bring down the currency’
“If you can identify the shock, and if you can offset the shock, then there’s a case to be made for it,” McKibbin said.
“I wouldn’t say I regretted what occurred, because when you start reading that Paul Howes, who’s a union leader in Australia, agrees with me, then my first thought was, probably I’m wrong. Actually he wasn’t agreeing with what I said, he was agreeing with other people’s interpretation of what I said – to bring down the currency,” McKibbin said.
“I never said ‘to bring down the currency’; I said, ‘neutralise the shocks so you can better identify what’s happening, and that makes monetary policy easier, if you can reduce some uncertainties,'” he said.
Arguing that the RBA should print money with the intention to lower the currency was a dangerous slope to go down.
“What could start off as a very sensible argument could end up in a landslide attack in the market. That’s the last thing I want to see occur. But I think the debate has to be had that, there’s no market anywhere that’s completely free,” McKibbin said.
“There’s always some government somewhere intervening. The question is, if that’s happening, then maybe your response is to actively intervene as well,” he said.