Category: Banking

Source: Airservices Australia

Introduction

It is a great honour to address you on the 100th anniversary of the Economics Society of Australia.

It’s an honour because, over that past century, Australian thinkers have helped develop some of the most important building blocks in open economy macroeconomics – the branch of economics that seeks to understand how the global trading economy works.

Those were significant – sometimes world-leading – intellectual achievements.

But they were more than just that. Because they also shaped the policies and institutions that helped Australia navigate the global economy of that period so successfully, delivering wealth and stability for its citizens.

Indeed Australian macroeconomic research has pulled that trick off twice. First, powering the ideas that lifted the country out of the Great Depression to flourish after the Second World War. And, second, helping to design a reform program that rescued the country from the slump of the 1970s, and led to more than a quarter century of recession-free growth.

Two Golden Ages, marshalling thought into action.

But to thrive in the next 100 years, Australia’s researchers will need to go for the hat-trick.

And that’s because the tectonic plates of the global economic system are once more in flux, as free trade is rolled back; geopolitical alliances shift; climate change accelerates; and productivity growth slows to a crawl in most developed countries.

Simply coping with such changes will take skill. Turning them to Australia’s advantage – identifying and exploiting new trading structures and sources of growth – will require rich new thinking from Australian academia.

The good news is that many of today’s policy problems lie at the very heart of Australia’s intellectual comparative advantage. The challenge is whether we can relearn the lessons of the past – drawing in our best talent, strengthening the incentives for policy-relevant research, and forging deep links between academics and policymakers.

In my remarks today I want to look back at some of those successes of the past century, before posing some questions for the future.

What is Australian macroeconomic thought?

But before doing so, I should try to clarify what I mean by Australian macroeconomic thought.

Is it macroeconomic research about Australia? By Australians? Conducted in Australia? It could be any of the above. But if you wanted a ‘vibe’, in the great Australian tradition of The Castle, I’d suggest three defining features:

• First, an emphasis on small open economy macroeconomics, with a particular role for the commodities and energy sectors. That reflects the nature of our economy and the challenges we face. But it also has global application: our context is also our comparative advantage.
• Second, a focus on solving practical real-world policy issues, rather than pushing forward more abstract frontiers. Many influential Australian macroeconomists have also served as senior public policymakers.
• Third, a world-leading capacity to develop the analytical tools necessary to drive successful economic policy – in particular small open economy quantitative macro-models and macroeconomic data.

The past 100 years: Two ‘Golden Ages’ of Australian economic thinking

To illustrate how these themes played out over the past 100 years, I’m going to split the period into two halves. The first lies either side of the Second World War; the second straddles the economic reforms starting from the 1980s. Each in its own way can legitimately be called a Golden Age, in which Australian ideas both advanced the global knowledge frontier and delivered prosperity for Australia.

The first Golden Age

The first period, from the birth of the ESA in the 1920s to the late 1960s, saw Australia pull itself out of the depths of the Depression and navigate a world war.

Australia’s response to these challenges was shaped by its economic context as a small commodity exporter. For much of the period, the growth model relied on expanding exports of raw materials (primarily agricultural), using huge quantities of imported labour and capital. The central question in such an economy was how to maintain both internal and external balance, in the face of external shocks. To achieve these goals, the authorities relied primarily on centralised control. The exchange rate was pegged to sterling; credit volumes and interest rates were typically administratively set, and wage-setting was heavily institutionalised. Tariffs were used actively, in an attempt to protect and foster domestic industry, lift employment and reduce the economy’s reliance on volatile global commodity markets.

Many great Australian thinkers helped shape this first Golden Age – but today I will focus on just two.

The first is Lyndhurst Giblin.

Giblin was a model Accidental Economist. He devoted his first 45 years to everything but the subject: he was part of the Klondike gold rush, served as a Tasmanian MP and received the Military Cross for gallantry on the Western Front. Yet little more than a decade after the First World War, Giblin had developed one of the most important building-blocks of macroeconomics.

As Government Statistician for Tasmania and later Ritchie Professor of Economics at the University of Melbourne, Giblin had a ringside seat for the Great Depression – which in Australia began in 1928 as commodity prices fell, accelerating in 1929 with the global slump. Giblin saw that sharp declines in world prices for agricultural produce – Australia’s main export – would not only lower Australian farmers’ incomes, but would also cause them to spend less. And that in turn would lower incomes for others, causing a slump to ripple out through the wider economy. That rippling could be far larger than the first-round impact alone, amplifying the domestic repercussions of a global shock.

Giblin set out this startlingly simple but revolutionary idea – the modern-day multiplier in all but name – in a 1930 lecture. That’s a year before Richard Kahn’s seminal Economic Journal paper, and six years before Keynes’ General Theory. What is today known universally as the ‘Keynesian multiplier’ could and perhaps should be called the ‘Giblin-Keynes multiplier’. Yet neither Kahn nor Keynes made any reference to Giblin’s work, or even appeared aware of its existence.

Giblin, however, was far less interested in global acclaim than he was in working out how Australia could rescue itself from the Depression – and that was a hotly contested question. The then Premier of New South Wales, Jack Lang, had a simple answer: default on state and Commonwealth debt to the United Kingdom and use the savings to stimulate domestic activity. But default risked destroying Australia’s future borrowing capacity, rendering its economic model unworkable.

The Bank of England, in the form of the widely disliked Otto Niemeyer, had a different proposal: cut wages and balance the budget. Based partly on his multiplier analysis, Giblin worried that approach would be too deflationary. With Douglas Copland, Leslie Melville and others, he helped prepare the 1931 ‘Premiers Plan’, which argued that Australia should accompany lower wages and a balanced budget with monetary easing to ‘spread the loss’. A sharp devaluation against the British pound, executed the same year, provided further support to external competitiveness. Giblin framed the challenge as tackling an ‘outside problem which is causing an inside problem’ – concepts that years later would be formalised as external and internal balance.

Although Giblin used what would come to be thought of as a ‘Keynesian’ analytical tool (the multiplier), his policy prescriptions were decidedly un -Keynesian: this was no debt-financed fiscal expansion. Writing in the Melbourne Herald in 1932, Keynes himself recognised the plan ‘saved the economic structure of Australia’. But he advised against its wider use, arguing that competitive devaluation or wage deflation would leave no-one better off, and advocating ‘public works’ rather than ‘further pressure on money wages or a further forcing of exports’.

Giblin’s thinking evolved in the same direction over time, and by the end of the Second World War he favoured using government spending to stabilise the economy and keep unemployment low. That view informed Australia’s position at the Bretton Woods conference, where it argued that relaxing trade protections – a key goal of the United States – without also committing to full employment could leave countries like Australia badly exposed to external shocks. And it formed the core of the 1945 Full Employment White Paper, developed by Giblin alongside Melville and ‘Nugget’ Coombs – later the first Governor of the RBA – which set the basis for policy in much of the post-war period.

My second case study is Trevor Swan – regarded by many as Australia’s greatest economist.

Swan made not one but two key contributions. The first is summarised in the ‘Swan diagram’, and extended in the ‘Salter-Swan’ model developed with fellow Australian Wilfred Salter. The model is designed to help think about policy coordination and trade-offs in a small economy like Australia, with trade and a fixed exchange rate. The model elegantly demonstrated many of the issues the country faced in the first Golden Age trying to achieve both internal and external balance. And it illustrated how different combinations of macroeconomic tools – including fiscal, wage, exchange rate and trade policy – might be used to maintain both in the face of international shocks.

Swan’s second seminal contribution was aimed at thinking through how to foster longer term economic growth. Swan showed that medium-term growth in real per capita labour income depends on the rate of technical progress, growth in the labour supply, and growth in the capital stock. This was a crucial insight for Australia, which relied heavily on high rates of immigration. Swan’s framework showed that, in such circumstances, sustained growth in real incomes also required rapid growth in productive capital and technical progress. Without that, real incomes would stagnate or fall. Important messages for policymakers at the time – and still relevant today.

Swan’s personal story is fascinating. Amongst other things, he was a perfectionist, and that – combined with his preference for supporting Australian economics – led him to publish his work slowly (if at all), and exclusively in local journals. As a consequence, much of the credit for his pioneering ideas on growth, including a Nobel prize, went to Robert Solow rather than Swan. But like Giblin, Australia mattered more to him than global fame. Alongside his role as ANU’s first Professor of Economics, Swan was Chief Economist to the Prime Minister’s Department (in the 1950s) and a member of the RBA Board (from 1975–1985).

The second Golden Age

The second Golden Age – from ideas to action – straddles either side of the deep economic reforms of the 1980s and 1990s.

The reforms overturned the paradigm of the first Golden Age. The exchange rate was floated. High tariffs were replaced with much freer trading arrangements. Constraints on the financial sector were released; and, in time, the central bank was made independent and asked to hit an inflation target. Of course, there was good luck too, as huge new export markets opened up in Asia. But taken together, these changes ushered in an extended period of prosperity for Australia.

The intellectual groundwork for the reforms was laid years earlier, as recognition dawned that frameworks of centralised control and protectionism were undermining, rather than protecting, competitiveness, productivity growth and living standards. This was far from unique to Australia, of course. But Australian thinkers again made important contributions to the evolving global consensus – perhaps most notably on the case against trade protection, through the work of Max Corden. Corden showed that the economic costs of tariffs were much larger than previously recognised, once general equilibrium effects were accounted for. His work, including the concept of ‘net effective rates of protection’, which captured the impact of tariffs on imported inputs as well as outputs, remains widely cited – and, sadly, is highly topical again today.

Like his earlier compatriots, Corden did not just push forward academic thinking – he also rolled up his sleeves and got stuck into policymaking for Australia. His work had a profound impact on the enquiries led by John Crawford over the 1960s and 1970s calling for a rationalisation of tariffs. And it led, through the advocacy of Fred Gruen, to the Whitlam government’s across-the-board 25 per cent cuts in tariffs in 1973, which began the long and winding road to free trade. The Tariff Board was renamed the Industries Assistance Commission – and two decades later became the Productivity Commission: quite a journey!

The reforms of the Second Golden Age reflected a dawning recognition that – subject to safeguards – flexible market prices could facilitate adjustment to both internal and external shocks more effectively than administrative controls. These were not uniquely Australian ideas (Ross Garnaut called it ‘the Washington consensus come to Australia’). But strong advocacy by the government and wider public institutions helped them take root. And the overlay of specifically Australian policies – including the 1983–1996 Prices and Incomes Accord – helped maintain social and political support for reform. The strength of such equity considerations, familiar from Giblin’s work in the 1930s, remains an important feature in Australian macroeconomic policy debates to the present day.

Across both Golden Ages, Australia also had a world-leading role in two areas of practical policymaking: quantitative macro-modelling; and economic data.

Australia’s first general equilibrium macro-econometric model was developed in the early 1940s by – who else – Trevor Swan! Indeed Swan’s model has a decent claim to be among the first globally, coming after Jan Tinbergen’s 1936 model of the Netherlands but more than a decade before Lawrence Klein and Arthur Goldberger’s model of the United States. Once again, Tinbergen and Klein both received Nobel prizes; Swan (who didn’t even publish his model during his lifetime) did not. From the early 1970s, the Treasury and RBA built a suite of state-of-the-art open economy macro-econometric models. ORANI, one of the most advanced large-scale computable general equilibrium models of the time, was used in the Crawford enquiries. And in the 1990s, Warwick McKibbin and Peter Wilcoxen developed the global hybrid DSGE/CGE model, ‘G-Cubed’, used most recently to provide widely cited assessments of the impact of US tariffs.

The strength of Australia’s economic data has an even longer pedigree. As the first Government Statistician of New South Wales from 1886, Sir Timothy Coghlan produced a series of yearbooks that set global standards for the measurement of aggregate income and occupational classification in national censuses. Half a century later, Keynes’ disciple Colin Clark helped bring modern national income accounting to Australia. And there have been many other examples of methodological trailblazing since then – including early adoption of survey sampling approaches and an integrated business register; and pioneering use of satellite imaging and integrated data sets. The critical importance of effective data gathering to Australia’s economic success was reflected: in its independent institutional setting at the heart of government; in its job titles – the head economic adviser to government was for some time known as the ‘Chief Statistician’; and in its ability to attract some of Australia’s top minds, from Giblin, Sir Roland Wilson and Charles Wickens right up to today.

Before I leave this brief stroll through the past, I should acknowledge the key role that the ESA itself played in this history. Many of those I’ve talked about today were presidents of the Society; and many of their ideas appeared in its publications. Like Australian macroeconomics in general, a defining feature of the Society has been its focus on ideas that can be implemented, not just admired. Douglas Copland, ESA’s first President, encouraged members to involve themselves in the practical affairs of government and business – a principle captured in the Society’s aim ‘to encourage the teaching and study of economics and its application to Australia’. The RBA has long been an active supporter of that program. Bernie Fraser held the Presidency of the Society while he was RBA Governor in the early 1990s, hosting central council meetings in the Bank’s boardroom in Martin Place. And two of our current Department Heads played leading roles more recently: Jacqui Dwyer was an executive adviser on economics education; and Penny Smith was President of the NSW branch, supporting the launch of the Society’s Women in Economics Network.

Will there be a third Golden Age? The worry … and the call to arms

By any standards, then, the past century has been an extraordinary story – of world-leading thinking, deployed by the country’s best academic minds, working hand-in-hand with policymakers, helping to pull the economy from the jaws of global turmoil and setting it on the path to prosperity.

So the killer question is this: can Australian macroeconomic thinking do it again, as the world economy is once more in flux?

Ask that question of the macro research community today, and some seem worried:

• about Australia’s ability to attract, retain and grow top academic talent;
• about diminished academic incentives to work on issues of greatest policy relevance to Australia; and
• about perceptions of a weakened partnership between academia and policymakers.

Views differ on how serious those worries are. The best Australian research remains world-class. And we don’t need to solve everything ourselves: the scope to draw on global thinking, adopting and adapting it to Australian conditions, is far greater than in Giblin’s day.

But, where there are concerns, they should be seen as a call to arms, not a cause for despondency. And that’s because the defining macroeconomic challenges of our age – the rolling back of free trade; the implications of shifting geopolitical alliances; climate change; and the need to reinvigorate productivity growth globally – lie right in our areas of comparative advantage.

The question is how to leverage that advantage. Let me break that into three sub-questions.

How can we build on Australia’s historical strength in open economy macro?

The long arc back to a more regionalised, less open, international trading system, coupled with the realities of climate change, poses fundamental questions for Australian macroeconomic research along at least three dimensions:

• First, how will the composition and geographical location of our export markets change in response to evolving trade policies and geopolitical alliances? What implications will those shifts have for domestic output, investment, labour markets and pricing? And how do we harness our natural and human resources to take advantage of those shifts?
• Second, how will global commodity demand change over time? How long will markets for ‘traditional’ minerals including coal, gas and iron ore – mainstays of the economic model in Australia today – persist? Will markets for ‘new economy’ minerals and renewable energy sources take their place, and how can Australia best position itself to take advantage of such trends?
• And, third, how will these and other structural shifts change the sorts of shocks that stabilisation policy, including monetary policy, needs to respond to? How will that influence optimal policy design? And how might we need to adjust our thinking about trade-offs, across the different policy goals and tools available?

Understanding the macroeconomic risks, and opportunities, from these structural changes is a vital priority for research – to protect the economy, but also to ensure a clear path for future growth. The good news is there is a rich history of Australian macro research and modelling to draw on. The challenge is that this will only take us so far: dealing with tomorrow’s world will require us to apply and extend that research to answer new questions.

How can we deepen the links between academia and policymakers?

Second, how can we deepen the links between academia and policymakers – the secret sauce of the first two Golden Ages?

There are certainly some great examples today. Several Commissioners at the Productivity Commission are current or former academics, including Catherine de Fontenay, ESA’s President. The Treasury’s competition review has an expert advisory panel, including academics. And many of our top universities and think-tanks have groups focused on fostering engagement on macroeconomic policy issues.

One of the most profound issues of our time is how to reverse the productivity slowdown. This is by no means a uniquely Australian challenge – but the Second Golden Age demonstrated the power of harnessing academic ideas and policy to drive a long-term recovery in productivity. Important work is underway on this topic in the public sector, some of it in conjunction with academia: for example, researchers at the Productivity Commission, Treasury and RBA have analysed the causes of the productivity slowdown, its links to competition, innovation and dynamism, and the implications for the wider economy. And the Commission currently has five separate inquiries underway into potential practical reforms, which among other things will serve as inputs to the Government’s Economic Reform roundtable in August.

A lot of research in this space makes use of Australia’s excellent microdata. The availability, quality and breadth of Australian de-identified datasets on business and individuals is comparable to anywhere in the world – due in no small part to the excellent work of the Australian Bureau of Statistics, as well as the Australian Tax Office and Department of Social Services. Being at the forefront in this space offers scope for researchers to do globally relevant and frontier work, in an Australian context: the best of both worlds. For example, at the RBA we are currently using it to assess frontier questions around how monetary policy affects labour supply, and how pricing dynamics changed during the recent increase in inflation.

How can we communicate the urgency of the challenge?

Third, what can we do as a community to communicate the urgency of the challenge, to show its importance and draw new talent into this vital work? Bringing academics, policy economists and policymakers together can help us reach a common understanding, of both the problems and the potential solutions. In that context, conferences like this one can be extremely powerful, as can the work of the ESA more generally. But it is crucial that both sides – policy and academia – buy in. And we need to focus, as a profession, on how we communicate our thinking. The Golden Ages were full of people like Giblin who specialised in translating big ideas into simple language. As Danielle Wood argued at last year’s APS Economist conference, it has never been more crucial for economists to speak directly and plainly.

The role of the RBA

Many of those I spoke with in preparing this speech emphasised the leading role that the RBA could play, as one of the most prominent consumers and producers of Australian macro research; and as a training ground. The RBA has a rich history at the leading edge of central bank research – and we remain engaged across a wide range of issues today. But as I’ve already noted navigating the complex and unpredictable world of tomorrow will pose big new challenges.

That’s why, spurred on by the findings of the RBA Review, the Bank will be refreshing its research strategy, with a new set of priorities, identifying the big questions that need to be answered to support future policymaking. We’ll use those priorities to hold ourselves to account – but we’ll need external help too. Part of that will involve deeper collaboration on specific research topics, building on the centres of excellence here in Australia. And part of it will involve finding new ways to come together collectively, building on our existing workshops and conferences, and our six-monthly academic advisory panel. Here too there is more than an element of ‘back to the future’ – it was nearly 75 years ago when Coombs, as head of the Commonwealth Bank, the de facto central bank, first conceived of convening senior academics to critique the exercise of policy. As we face into a more complex world, we need that support and challenge more than ever.

Conclusion

Let me conclude.

A 100th birthday is always a cause for celebration.

For Australian macroeconomics that is true with bells on.

Two Golden Ages, forged in response to fundamental shifts in the global paradigm – powered by world-class thinking, ruthlessly applied to a single end – improving the lot of the Australian people.

As the global paradigm shifts again, the challenge is to go for the hat trick.

The good news is the policy questions facing us, and the world, lie four-square in Australia’s areas of comparative advantage.

But to exploit that advantage, we need to relearn the lessons of the past – drawing in our best talent, strengthening the incentives for policy-relevant research, and deepening the links between academics and policymakers.

As a trading economy reliant on world markets, we have no choice but to respond. But we can go one better: by marshalling our best brains we can turn this challenging environment to our advantage.

At the RBA, we stand ready to play our part in this great endeavour.

Thank you.

MIL OSI News –