exchange rate and thwart the speculation. as capital inflow continued to mount during november, the reserve bank actually devalued the australian dollar against the twi. 2 attempts to frustrate the speculators were unsuccessful. inflows continued. finally, the exchange rate was floated on 12 december 1983 and most of the remaining capital controls were removed simultaneously. australia was one of the few countries to have taken a decision to float when the currency was under upward pressure, because the capital inflow just could not be adequately absorbed. the decision has rightly been regarded as one of the most important ever taken by an australian government in the field of economic policy, for a number of reasons. most important from the perspective of monetary policy, the system for control over the amount of settlement funds in the system became fully effective for the first time. if the reserve bank wanted to tighten financial conditions, by taking funds out of the system, the private sector could no longer immediately offset that by getting those funds back by selling foreign exchange to the reserve bank : we were no longer obliged to buy or sell foreign exchange at a given price. g. debelle and m. plumb ( 2006 ) ‘ the evolution of exchange rate policy and capital controls in australia ’, asian economic papers ( forthcoming ). in summary, the operation of monetary policy in the pre - float period was significantly constrained by external considerations, and was hampered by capital flows. while we had a quantitative target for monetary growth, we had no way of exerting the required control in order to achieve that outcome. eventually, this system was overtaken by events and we had to change it. over a number of years, we evolved towards a floating exchange rate with a medium - term inflation target. let me now turn to the more recent episode of australia ’ s experience during the asian crisis, to illustrate how that arrangement worked. when capital flows were not quite so much of a problem at the onset of the asian crisis in mid 1997, the australian economy was growing at around trend rates, with domestic demand beginning to accelerate, and underlying inflation below 2 per cent. given the inflation performance, monetary policy had been eased over the previous year as required by our 2 – 3 per cent inflation target. thus, the shock hit the australian economy at a time when it was in reasonable shape with the stance of monetary policy already relatively expansionary. exports to east asia accounted for around one - third of australia ’ s exports at the time, so

been not very different from what it was towards the end of the managed exchange rate era in the early 1980s. graph 1 o. j. blanchard and j. simon ( 2001 ) ‘ the long and large decline in u. s. output volatility ’, brookings papers on economic activity, 1, pp. 135 – 164. d. gruen and g. stevens ( 2000 ), ‘ australian macroeconomic performance and policies in the 1990s ’, in d. gruen and s. shrestha ( eds ), the australian economy in the 1990s, proceedings of a conference, reserve bank of australia, sydney, pp. 32 – 72. short - term variability of the exchange rate is not necessarily costless, of course. some people might argue that it creates a degree of uncertainty for exporters and importers, and those allocating capital. but the share of australia ’ s real economy engaged in international trade, and the extent to which australians ’ financial assets are traded internationally, have grown over the same period. no doubt this was mostly a result of the general opening up of the economy to the international system, but it is difficult to support the claim that exchange rate variability has seriously impeded these developments. on the contrary, i think that the most serious potential problem for the internationally exposed sectors is not short - term exchange rate variability, but medium - term misalignment in the exchange rate. allowing market forces to move the exchange rate makes such an outcome much less likely. better monetary control afforded by the flexible exchange rate, on the other hand, has been an unalloyed benefit to all sectors of the economy, traded and non - traded. lest this sound as though we never have a care in the world about the exchange rate moving, however, it is important to add one caveat to this story. it is this : a strong monetary policy framework is essential. indeed, there were plenty of times when the movement in the exchange rate, especially downward ones, made the reserve bank quite uncomfortable. looking back, these were mostly periods when the policy framework was not as well developed, or as credible, as it is today. on occasion, it seemed that the exchange rate was moving because of a change in confidence about the conduct of economic policies, including monetary policy, in australia. this was more a feature of the 1980s, when the medium - term inflation targeting framework was not yet in place, though some episodes in the early 1990s were also troublesome as the