Real gross domestic
income grew at an annual rate of 4.2% per annum in the USA between 1949
and 1973. Since the US exchange rate was floated in March 1973, the
rate of economic growth has declined to average 2.7% up until 2011.
In Australia, real gross domestic
income was growing at an annual rate of 5.2% per annum between
1960 and 1973. That was under the fixed exchange rate
system. Between 1973
and 1983, after the USA had floated its currency but before Australia
had floated, the average real rate of economic growth in Australia declined to 2.0%.
Since 1983, when Australia floated its exchange rate, real gross domestic income has grown at
an average rate of 3.8% per annum (to 2009). Rather than raising
the rate of economic growth, floating the exchange rate has slowed
the rate of economic growth by 34% in the USA and 27% in Australia.
Floating the dollar has had an effect on
wages growth. In the USA, average weekly earnings for the
private non-farm sector was rising at 1.2% per annum in real terms,
from 1964 to 1972, immediately before the US dollar was floated. In the next 20 years they declined at
an average rate of 1.2% per annum. Then between 1992 and 2004, they have been rising
slowly at an average rate of 0.6% per
annum in real terms: half the rate of the first period. Even
real wages for private non-farm workers in the USA in 2010 are
still 16% below the levels they were in 1972 as shown in Figure 1.
If average real wages in the US had maintained
their pre-float growth rate, they would be 70% higher
than they are today.
Figure 1. USA: Average
Weekly Wages at constant 1992 prices for all private non-farm workers
Source: US Bureau
of Labour Statistics
In Australia, average
real wages were rising up until June 1984. The real rate of
wages growth had been around 4% between 1969 to 1975. Then it slowed to
0.6% until 1983 when Australia floated its dollar. It jumped
more than 8% in the year to June 1984 following the float,
when the value of the Australian dollar declined rapidly.
In the six years from June 1984 to
June 1990, average real wages declined at an average rate of
more than 1.6% per annum. Since then, average real wages have been rising
at about 1.4% per annum. Despite this improvement,
the rate of real wages growth is less than half the rate of the 1960ís and 70ís. Average real wages did not
return to their June 1984 levels again until June 2003. That
is, Australia experienced nineteen years without any growth in
average real wages above 1984 levels. Average real weekly wages for Australian
workers are shown in the Figure 2. As minimum wages are
regulated in Australia, Australian workers did not experience
the same dramatic reduction in wages as in the USA.
Figure 2. Australia:
Average Real Weekly Wages (Discounted by CPI base 1989/90)
Floating the dollar
affected unemployment, also. In the USA, the rate of unemployment has
increased significantly since 1973 when the US dollar was floated,
as shown in Figure 3.
USA: Unemployment Rate
In Australia, unemployment was
below 2%, generally, in the 1950ís and 60ís. From 1973, when the US
dollar was floated, unemployment rose rapidly until 1983, when the
Australian dollar was floated. Since then, unemployment has been
relatively high, rising and falling with the economic cycles as
shown below in Figure 4. Unemployment fell to below 4% in Australia in 2008
before rising again in 2009. In addition to the unemployed,
Australia has experienced a large increase in the number of people of working
age receiving government pensions. The number of working age people on
pensions far exceeds the official level of unemployment.
Therefore, the effective rate of unemployment is significantly
higher than revealed in the official statistics.
4. Australia Unemployment Rate
R.G. Gregory ďA Longer Run Perspective on Australian Unemployment" &
Australian Bureau of Statistics
1973, when the US dollar was floated, the Australian dollar was
tied to the US dollar. From September 1974, the Australian dollar was
tied to as basket of currencies until it was floated in December 1983.
The Australian dollar had been worth US$1.4875 in 1974. By mid 1983,
its value relative to the US dollar had fallen below US$0.90.
The exchange rate links and changes help explain why Australia was affected
by the floating exchange rate system, even before it had adopted
equilibrium under fixed exchange rates
main reason for the changes in wages growth and the level of
unemployment is related not so much to the exchange rate itself, but to the way
the fixed and the floating exchange rate systems attain equilibrium.
following charts explain the issue. The output, income, imports and exports of
an economy are represented
on the horizontal axis. The exchange rate is fixed at e1.
In Figure 5, the economy is initially at equilibrium with exports (the supply of
which is represented by the X1-X1 line)equal to imports (the demand for which is represented by the M1-M1
at the point A1. The total national income or output of the
economy is at the point Z1. The economy earns income from
exports equal to 0-A1 and from domestic sales of A1-Z1.
It spends 0-A1 on imports and A1-Z1 on
Figure 5. The
initial equilibrium position (fixed exchange rate)
Figure 6, we assume that there is a permanent increase in the supply
of exports from the X1-X1 line to the X2-X2
line. As the exchange rate is fixed, exporters will supply
exports of 0-A2. The income from exports will be equal to
0-A2 while the income from domestic sales will initially
be at A1-Z1. Adding the income from exports
to the income from domestic sales raises total income to 0-Z2.
There is now disequilibrium in the economy with exports exceeding imports and
with national income, or output, rising.
Disequilibrium- an increase in exports (fixed
The increased national income enables the economy to increase its
spending. This expenditure is directed at both domestic products
and imports. As the exchange rate is fixed, the proportion of
spending spending on domestic products and imports will
tend to be fixed. The proportion of additional
income spent on imports is called the 'marginal
propensity to import'. The expenditure on domestic products raises national income
further. The expenditure on imports does not raise national
income. National income will continue to rise
while the income form exports is greater than spending
This growth in income from export sales is known as the multiplier
effect. The value of the export multiplier is equal to the inverse of the marginal
propensity to import. Thus if a country spends 10% of its
additional income on
imports, a $1 billion increase in exports would increase national
income by $10 billion. When the national income has increased $10
billion, the economy would be at equilibrium again with the
additional spending on imports equal to the additional income from
This new equilibrium position is shown in Figure
7. National income
has increased to 0-Z3 with exports equal to 0-A2
and the income from domestic sales equal to A2-Z3.
With the higher level of income, expenditure on, or demand for,
imports would have shifted to line M2-M2 with
spending on imports increasing to 0-A2. Thus in an
environment of fixed exchange rates, national income and aggregated
demand rise to achieve equilibrium.
Figure 7. New equilibrium-
imports rise to equal exports (fixed exchange rates)
It was in such an environment of fixed exchange rates that
growth in export income was able to stimulate the economies
countries such as Australia and the US so that they experienced
wages growth and high level of employment. Even with strong
union pressure to raise wages, demand for labour was
high and there was full employment.
equilibrium under floating exchange rates
The effect of floating the dollar
is described below. Figure 8
presents a similar equilibrium position to that shown in Figure 4.
Exports and imports are equal at 0-A1 with income from
and spending on domestic products equal to A1-Z1.
The exchange rate is floating and the exchange rate is initially at e1.
Figure 8. Initial equilibrium with floating exchange rates
in Figure 6 for fixed exchange rate system above, in Figure 9
we now assume that there is a permanent increase in the supply of
exports from the X1-X1 line to the X2-X2
line. As the exchange rate is now variable and set
in the market to ensure that international payments and
receipts are equal, the exchange rate rises from e1
to e2. At the new exchange rate,
spending on imports rise from 0-A1 to 0-A2 to equal exports. Imports
increase because the higher exchange rate makes them
cheaper. In the same way as for the example with fixed exchange rates, the income from
exports has increased form 0-A1 to 0-A2. However, the higher exchange rate has made domestic products
relatively more expensive and so spending on domestic products
declines from A1-Z1 to A2-Z1.following
the increase in spending on imports rising from
Therefore, despite the increase in exports, national income and
aggregate demand has remained constant at Z1.
Export growth no longer stimulates the whole economy.
Figure 9. New
equilibrium with increased exports (floating exchange rates)
Under floating exchange rates, the foreign exchange market changes
the relative price of imports and domestic products to shift demand
between domestic products and imports. International
transactions no longer raise national income in the domestic economy.
The exchange rate moves or floats to continuously
was the change in the means of achieving equilibrium that slowed
the rate of economic growth, increased unemployment and stopped
wages growth in countries such as the US and Australia that changed
from fixed to floating exchange rates. Under the
fixed exchange rate system, they had
enjoyed high rates of economic growth, high levels of
employment and wages growth, all generated by
increased exports. Floating the exchange rate removed the
forces of disequilibrium that had previously generated
growth and prosperity.
the environment of floating exchange rates growth in exports
increased imports and reduces local spending on domestic
products. In such an environment, export and import
industries grow more rapidly relative to import competing industries that
supply the domestic market. This growth in the relative size of
exports and imports compared to the remainder of the economy has
become known as globalization. In
Australia, imports and exports increased from between 12% and 14% of
national income to more than 20%. The Australian Government
recognizes that the high exchange rate is a problem for domestic industries. In the
Treasurer's 2011 budget speech he states that "the
dollar is around post‑float highs and this makes it
difficult for some sectors, particularly those that
compete in international markets."
10. Australia: Exports and imports as a share of GDP
In the USA, exports and imports
increased from between 4% and 5% of GDP to between 12% and 18% of
GDP as shown in Figure 11.
Figure 11. USA: Exports
and imports as a share of GDP
This rise in the significance of imports and exports is represented
in Figure 9 as the shift in exports and imports from 0-A1
(4%-5%) to 0-A2 (12%-18%).
While floating the dollar has increased trade as a share of GDP,
trade would have been significantly higher if there were fixed
exchange rates. Figure 12 can help us compare the effect of an increase in
exports under the fixed exchange rate system and the floating
exchange rate system.
Equilibrium with increased exports (comparing floating
and fixed exchange rates)
Under the floating exchange rate system, an increase in the supply
of exports from X1-X1 to X2-X2
would have prompted an increase in the exchange rate from e1
to e2 and an increase in exports and imports from A1
to A2. National income would have remained constant at Z1.
Under the fixed exchange rate system, an increase in the supply of
exports from X1-X1 to X2-X2
would have prompted an increase in exports from A1 to A3
and national income from Z1 to Z2. The
amount of international trade associated with the floating exchange
rate and globalisation is at A2
and is actually lower than the outcome with fixed exchange rates
which would have reached equilibrium at A3. This
lower level of trade was particularly hard felt in the ship-building
industries in the mid to late 1970ís when countries such as the USA,
UK and Germany floated their currencies. For
example, evidence for this reduction in trade is evident in events such
as the UK
Shipbuilding (Redundancy Payments) Bill 1978.
initial reduction in the growth of economic demand associated with
the change from fixed to floating exchange rate was called the World
Oil Crisis. This "spin", shifting the blame to oil prices, was accepted because the recession coincided
with a period of high oil prices. However, while oil prices were
high, they were not responsible for the recession. The
recession had started before the oil price increased.
Also, world trade
did not recover when oil prices fell. Oil prices have
risen again since then without the same damaging effect on the world economy.
US was able to eventually move out of recession through the growth
of bank credit. However, bank credit has not been as effective at
stimulating the economy as money from the growth of foreign
reserves. Also, it is more inflationary
causes current account
generally adds to foreign debt. So far this
century, the USA current account deficit has averaged
$1.6 billion per day.
Since 1973, US exports have tripled relative to GDP. If US exports
had tripled under a fixed exchange rate system US national income
would have tripled, also. The floating exchange rate system has
quarantined the US economy from receiving the benefits of trade growth
and free trade. In
addition, it has contributed to the rising level of
Australian exports have nearly doubled since 1983. If Australia had
continued with fixed exchange rates, its national income would
have been substantially higher, also. Floating the exchange rate has
slowed economic growth, reduced real wages and raised foreign debt.
has reduced world trade. Consequently, the whole world has been
made poorer by it. While China continues to have a fixed
exchange rate system and is profiting from it, trade
with China would have been greater if its trading
partners had not adopted the floating exchange rate system.
The fixed exchange rate system
generated economic growth, despite the inefficient
labour market, without a major education campaign and
without micro-economic reform. The floating exchange
rate system has not been able to generate significant economic
growth despite improvements in labour market efficiency,
extensive investment in education, micro-economic
reform and free trade agreements.
The reason for this is that these are attempts to
shift the economy away from the stable equilibrium
position. Efforts to improve productivity and make
domestic products more competitive on both domestic and
international market are attempts to move from
equilibrium and force
imports to fall and exports to rise. The floating
exchange rate responds to such attempts to change relative
prices by raising the exchange rate to make imports
cheaper again. Therefore, no matter how a country
tries to make its products more attractive, the exchange
rate system will respond to restore the relative prices
that bring equilibrium to the economy.
Export growth can be used again to raise demand to provide full employment
with market determined exchange rates.
This may be achieved with the fixed exchange rate
system. It can be achieved with external stability
using a variable exchange rate system designed to
achieve external balance and full employment such
as the guided
exchange rate and liquidity system or the optimum exchange rate system. The
principle behind the optimum exchange rate system is to provide incentives to the market to set
the exchange rate at a level that would achieve full
employment without excessive inflation. The
economy is allowed to export more than it imports and
thereby raise aggregate demand to a level that provides
full employment. A model
comparing the operation of the floating and optimum exchange rates
systems is available here.
The principle of the optimum exchange rate system is
explained in Figure 13 below. Assume that a country has
income of Z1 with exports and imports equal
to 0 - A1 and exchange rate
e1. Full employment would
be achieved if income were at
Z2. If incentives are given to
the financial system so that it maximise profits
at full employment income it would drive the exchange
e2. Exports would now exceed imports
and so national income would rise. It would stop rising when
imports have shifted the imports schedule from
M1-M1 to M2-M2
so that imports equal exports at A2 and
national income has increased to Z2 with
sufficient income to achieve to raise demand to a level
that provides full
Achieving full employment with the Optimum Exchange Rate System
In this example, the export
schedule stays constant. However, the lower
exchange rate raises the proceeds of existing exports
and is likely to stimulate additional exports so that
incomes rise to
In this case it is the demand for imports, or the the import schedule, that shifts
as national income rises to attain full employment.
There is another model of the optimum exchange rate
system in Figure 14 of the
formula for the current account balance page.
The optimum exchange rate system would
raise incomes and allows policies designed to improve
social welfare and the environment to be undertaken
without causing harm to the economy or to employment
Figure 14 below shows exports and imports
in the Philippines as a share of gross national product.
The Central Bank of the Philippines has modified its
exchange rate system to maintain its international
competitiveness. They have reduced the share of
GNP that was spent on imports by nearly half, from 52 per
cent to 27 per cent. However, as in Figure 13, the
economy has grown so much as a consequence that the real
amount of imports have increased 13 per cent over that
period, despite the reduced share of income spent on
Philippines- exports and imports as a share of GNP
While the approach in the Philippines is an ad-hoc
approach it shows that the exchange rate can be be used
to increase national income and employment.
"I am the most unhappy man. I
have unwittingly ruined my country. A great industrial
nation is now controlled by its system of credit.
We are no longer a government by free opinion, no longer a
government by conviction and the vote of the majority, but a
government by the opinion and duress of a small group of