'Paul Keating has warned that the gains secured by the 1990-91 recession - low inflation and wages restraint - could be lost'. This timely warning was reported by Paul Cleary in this newspaper on 29 November.
'That situation could come about, he believes, because Australia's poor productivity performance means that wages growth is now squeezing corporate profits'.
There is no doubt that Australia's poor productivity performance combined with upward pressure on money wages is a great risk to Australia's prosperity.
Keating's claim extends to having been the deliberate inflation slayer in 1990, creating the recession we had to have, Australia's Paul Volcker.
As someone with a claim to that crown, and with little reason to like Paul Keating, as I shall explain, I nevertheless must support his claim.
For me, the background to the drama was a long tradition of the RBA's research department calling for tighter monetary policy in order to kill inflation once and for all, although we supported the Bank’s gradualist approach.
In the circumstances of the mid 1980s the 'conditional monetary projections' (a Treasury initiative that the RBA supported with reluctance) had been abandoned, for good reasons, and no-one had yet seen the bleedingly obvious replacement by an explicit inflation target.
In defence of our failure to come up with this solution, I merely note that there was at the most senior levels a bias against any simple target for monetary policy, and the younger men were frequently given the benefit of a homily on 'Goodhart's Law', the proposition that any simple economic relationship relied upon for policy purposes would be destroyed by gaming against policy.
More immediate was the debate that led to the Treasurer's 'Banana Republic' statement. This is discussed at the end on the linked biographical essay. The advice of the Bank’s Research team in 1986 that Australia's international debt was in danger of exploding to unmanageable levels generated fierce debate both within the RBA and with the Treasurer when, after a lengthy delay, he was the recipient of the advice. I was roundly vilified by the Treasurer in that latter debate but when the next current account deficit supported my case in the clearest possible manner he capitulated. To this day I give him immense credit for persuading Cabinet to turn the budget deficit into a surplus, for getting Prime Minister Hawke to persuade the ACTU to cop a real wage cut and for endorsing the touch on the monetary policy brakes proposed by the RBA, all points in my initially vilified advice.
Less praiseworthy, arguably completely boneheaded, was his decision - never conveyed explicitly to me - that henceforth I was an unperson, cut out of the policy loop that was the main reason for working at the RBA in those days of derisory salaries and pathetic pensions.
During 1987-88 every month I argued before the board for tighter monetary policy and every month the board agreed but somehow interest rates kept falling. The argument was that the rising exchange rate was tightening 'monetary conditions' more than falling interest rates were easing them. This was completely fallacious, and is a powerful reason why the RBA today is suspicious of a similar argument when confronted with it, as it should be.
Distance lends perspective. While on several month's gardening leave – prior to starting a new career in the private sector - I wrote my 'Reflections on Central Banking'. This was published in Quadrant and created considerable interest in the mainstream press but its criticisms were pretty mild. Its most quoted conclusion was probably: 'I am one of those who believe that discretionary control over that system is necessary. I also believe that a degree of independence - certainly independence of thought and opinion - from normal political processes is also desirable, perhaps essential. But control is partly exercised by central bankers who are not elected by the populace. In a democracy, the question of accountability becomes crucial'.
After a year or so in the private sector my thinking was more unshackled and my views on 'independence' had developed. I wrote a paper headed 'Inflation: its costs, its causes and its cure', published in Policy in 1990. Its main conclusions were that inflation was much more damaging than generally believed and that an independent Reserve should be given control of inflation as its primary objective.
'Trying to achieve a lot of things is often a recipe for achieving little. In particular, it is hard for a central bank to have credibility in fighting inflation if it is also supposed to concern itself with restraining unemployment. This point has recently been argued by Sir William Cole, the distinguished former public servant. He asked: 'How long has the Reserve Bank gone along with things against its better judgment - not for crude political reasons but because of its own reading down of its charter?'
'I have already argued that the existing charter could be read differently. But there is a further point. It cannot be denied that, in Australia, the attempt to achieve too many objectives has meant that the primary aim of monetary policy, the elimination of inflation, has not been achieved. So it seems to me that policy overall would be more effective if the Reserve Bank were to be given as its main task the achievement and maintenance of price stability.
'This could be achieved by simply deleting (b) and (c) from the list of objectives in the existing Act. Or it could be achieved by a more wide-ranging revision of the Act, including changes to the composition of the Board, such as removing the Secretary of the Treasury and replacing part-time non-executive directors by full-time executive directors'.
Not surprisingly, this paper was set to create a lot of interest. Treasurer Keating was asked about his views of it. With characteristic buoyancy he simply said something like: 'Ah, Dr. Jonson. The principal architect of the low interest rates that have caused our problems'. When asked for comment I should simply have said 'That is just bullshit' but I was still inhibited by the tradition of respect due to the Treasurer by an officer of a non-independent central bank.
I called the Governor of the Bank, Bernie Fraser, and asked to be allowed to review the papers I had written during the time alluded to by Mr. Keating. Despite my point that the attack concerned my time as a loyal officer of the Bank, Mr. Fraser refused this request. He advised that, as I had put my head above the parapet, I should cop the consequences When I pressed the point he conceded that the Deputy-governor, John Phillips, would review my papers for the Board and provide his opinion. John later phoned to confirm that my memory was correct.
With no other support from my former employer I sought legal advice from a highly regarded defamation lawyer in a leading law firm. He agreed to take my case but after a day or two he called to say that, for the first time in his career, he had been told by his partners he could not take the case because it would put at risk other matters then before the Treasurer.
I eventually wrote to Mr. Keating pointing out that he was wrong about my advice and I was owed an apology. In short order, The Treasurer embarked on a charm offensive. In a long telephone conversation, he first explained how he had been mislead about my position in 1987-88 and promising eventually to put the record straight - not something I have noticed him doing, incidentally. He then made a vociferous complaint about the ‘wimps’ at the RBA who had refused to lift interest rates by the full 2 percentage points that he had demanded. I agreed with him about the RBA’s alleged mindset, but being in receipt of such a (totally deniable) gobbet of information was of course of little use to me. I pass it on now as a contribution to Australia's economic history and to support Paul Keating's claims as reported by Paul Cleary last week.
Paul Cleary also quoted Bernie Fraser as saying 'there were a lot of inflation hawks around'. I was certainly one of those, and I am certain that the article I have quoted was a useful input to the decision to finally kill inflation in Australia. I also know for certain that it had an impact on the Howard government's decision to create an independent central bank with a mandate to control inflation, a proposal not immediately endorsed by Bernie Fraser's Reserve Bank. Indeed, I have been told by a retired Secretary of the Treasury that the suggestion (from an international agency) for an independent, inflation fighting RBA was initially greeted with a derisive snort.
Of course, all such debates move on. I have argued in my Henry Thornton column in this newspaper that the RBA has consistently raised interest rates too little, too late. Also that the RBA should concern itself with a broader definition of inflation including asset inflation. And, in thinking about monetary policy at the global level, I have become doubtful that multi-country 'Taylor rules' for setting interest rates is now appropriate, especially when the United States has a tendency to set rates virtually at zero at times of economic stress. My forthcoming book on Great Crises of Capitalism discusses these matters in some detail.
Published today in The Australian.