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  • PD Jonson

On The Edge of Chaos

Biographical talk about Australia's financial system, presented at Melbourne University in June 1995. For young RBAers: be careful how much courage you bring to your work; and will you be supported by your bosses if you overrstep the mark?

Animal Spirits

Modern mathematicians have developed chaos theory with its many exciting insights. One popular account - the only type I could hope to follow - develops a compelling vision. It is that evolution proceeds the fastest in a zone described as being 'on the edge of chaos'. Throughout my career, the Australian financial system has been evolving at a faster and faster rate. At times, as in the late 1980's, individual firms have slipped past the point of stability, into the zone of chaos.

Finance globally is the grip of fierce competitive forces and is evolving quickly. How close we are to the zone of chaos is one of the biggest questions. I have been asked to speak tonight about some of my experiences in our rapidly evolving financial system. It is an unfinished story, one that I plan to participate in for a good while yet. But I hope you might be amused, perhaps slightly enlightened, by some of the anecdotes.

The Bending of the Twig

My father Norm was a fundamentalist Christian of the Presbyterian persuasion. Norm ran a small business, repairing and selling refrigerators, but he was much too kind to make any real money. Notwithstanding the modesty of his business returns, he, like so many other business people, was treated firmly, Dad thought harshly, by the taxation authorities.

Even when the business was almost moribund, Dad worried that the fiscal fiend would somehow catch up with the fact that he did the odd repair job for his pensioner mates, charging only the cost of materials. He also worried that the authorities would catch up with the fact that his home-brewed beer (which he constantly improved) greatly exceeded the tax-free limits for both quantity and strength. Dad and his pensioner mates used to drink the powerful brew behind locked doors, ever ready to swallow the evidence if a tax inspector knocked on the door.

An uncle named George ran a small shoe and boot-making factory in Brunswick. His particular beef concerned the unions, though no doubt the taxman also got a serve when Uncle George shared a home-brew with Norm in Mitcham. George died first, but he would have taken grim satisfaction from the fact that it was the unions, not the taxation department, who finished Norm.

Dad died a few days after a train trip home from Sydney, where he had visited me. The trip was interrupted in the early hours of the morning at Albury by a lighting strike. Dad and the other passengers, mostly arthritic pensioners, were required to carry their bags through a freezing Albury night for a good half-mile in order to complete their trip to Spencer Street by bus.

My mother Irene was highly intelligent but had no career outside the home. Even as a child I had dim intuitions of the waste involved, since Mum coped by creating domestic psychological complications which occasionally led to bouts of nervous exhaustion which required very unpleasant medical intervention.

Another seminal influence was the 1960/61 credit squeeze. I was fourteen and helped a grimly determined Norm stave off bankruptcy as business dried up and debtors welched on their bills. I discovered then that governments and central banks were not especially skilled at managing the economy. Although I did not realise it at the time, a major life interest in economic policy formulation took root. There had to be a better way, I used to tell myself, personal experience reinforced by writers such as George Bernard Shaw and George Orwell.

It was about this time that I suffered a near-fatal illness that left me blind and paralysed from the waist down for some time, and not expected to recover even if I survived. (Mum, who did not always cope well with the minor dramas of life was magnificent at this time.) I missed a couple of month's schooling and in those days no one seemed to think that remedial teaching might be needed.

Having made an unexpected recovery, I was (surprisingly, even to me) back in the football team well before I was back on top of the lessons. From being one of the best students I was a struggler, but on the football field I was fearless and extraordinarily determined, as the illness had transformed me from a bit of a softie to someone far far tougher. In the final year of school it seemed that I would fail my exams, though I was an effective captain of the first eighteen.

A family friend, who taught at Scotch College or Melbourne Grammar, provided their teaching material which I worked through in the back row of the classrooms at Nunawading High School (no one seemed to notice, or if they did they turned a blind eye). After a while boredom set in, and then another Uncle, also called George, offered me a job at Baillieu Allard Real Estate, which I took with glee. 'No more study' I said as I learned how to phone clients and to hold the tape for the chief valuer in some of Melbourne's finest houses.

Fortunately my boss, Ron Serpell, insisted that I take off a week on full pay to sit the final exams. Much to everyone's surprise I passed, well enough in fact to win a Commonwealth scholarship to Melbourne University. I promptly turned this down on the grounds that I already had a good job, but fortunately several years later I was able to take up a place at Melbourne, initially as a part-time student in the Commerce faculty.

One thing led to another and before long I was a full-time, member of the honours course, being taught by Geoffrey Blainey, Jean Polglaze, John and Marj Harper, Wilfred Prest, Sam Soper, Ern Boehm, Jim Perkins and other great Melbourne teachers. John Maynard Keynes was my hero, both for the General Theory but also (in particular) the Economic Consequences of the Peace.

Economic history was a wonderful antidote to the more arid reaches of theoretical economics and there was the rare privilege of being taught by Geoffrey Blainey. He was an inspiration to practically everyone who met him, or saw him in action in the lecture theatre. I chose as an essay topic the effects on the world economy of the 1848 Californian gold discoveries, and was invited to discuss the paper with Geoffrey Blainey and Marj Harper, and it was a serious workout, not just an idle chat. It was a heady experience, and one that fed my emerging interest in monetary economics in an obvious way.

Late in my time at Melbourne I discovered (in the library, not in any course provided at MU in those days) the work of Milton Friedman, who challenged the socialist beliefs which I had picked up (much to Dad's disgust) from the bookshops and coffee houses of Carlton. My honours thesis was an attempt to apply Friedman and Schwartz’s monumental Monetary History of the United States to Australia for the time from 1926 (when reasonable data began) to 1969. I got different results from Friedman, as I concluded that in Australia the money supply was demand determined, and both inflation and most of the effects on our economic cycle came from abroad. Australia's exchange rate had largely been fixed, so this was a correct result, but we had not been taught any of the standard results in this area. Although I did not know it, I had discovered a key part of what became known as the monetary approach to the balance of payments.

Together with later work on the causes of inflation in Australia this gave me privileged access at the London School of Economics to Harry Johnson, with Friedman one of the towering economists of his generation. I went to the LSE via the Reserve Bank.

After completing my honours degree I stayed on at Melbourne as a tutor. One day the phone rang and a growley-voiced individual, Austin Holmes, introduced himself. Austin was the Head of Research at the Reserve Bank and his approach was typically direct. 'I want to make you an offer you can't refuse' he drawled. 'If you come to work at the bank we'll send you to the university of your choice to do a Ph.D., on full pay.' I was stunned, and after a silent moment asked 'Why me?' 'Good question' growled Austin. 'You are the only bastard in Australia doing research on monetary policy, and I'm told it's not all crap.' I accepted the offer then and there and went home (in the manner of the time) to tell my then wife that we were moving to Sydney.

One other bit of research done at Melbourne, with fellow tutor Dennis Mahoney, was on the measurement and explanation of inflationary expectations. We concluded that inflationary expectations were formed by the recent history of inflation, (by George, the uncles exclaimed, what an insight!), but also that the growth of money supply had an effect. Though there were debates about aspects of this study's econometric methods, the findings were more or less confirmed by more rigorous types, including Ross Williams of this university.

My year as a tutor was marked by active membership of the North Carlton branch of the Labor party. I gave a number of talks on economics at local branches, and developed a nice line of patter to explain why the latest budget had been too tough. 'Everyone knows,' I opined confidently, 'that silly Billy (the Treasurer of the time) never wins in cabinet. So Treasury winds him up to be much tougher than even it wants. The trouble is, Billy had an unexpected win!'

The other highlight of my contribution to the Whitlam government was to help organise the preselection of Gareth Evans. His main qualification, at least among the young Turks of the North Carlton branch, was his wife Merrin. 'He can't be a complete dill if she married him' we decided. To be fair, Gareth's main competition was Barrie Jones, and we found ourselves struggling to make our decision.

Economics at the RBA

When I arrived at the Reserve I was delighted to discover that people in its Research department at least believed that the financial system needed to be deregulated, with credit for this mostly going to the Head of Research, Austin Holmes. As a relative newcomer I was appointed to a committee to help write a talk for the then Deputy-governor, Harry (later Sir Harold) Knight. ('A committee to write a talk!' said the Uncles.) After briefing us, Harry asked if there were any questions. 'Do you believe Australia should have a floating exchange rate?' I asked. Harry pursed his lips and said something to the effect that, with Saint Augustine, he wished to be made pure, but not yet. This was his attitude to this question asked some years later by the Campbell committee.

At the Reserve my full-time job was part of the “Special Projects” section of Research dept. Most of the team was working on the 'RBA Model' of the economy under Bill Norton's expert leadership. I was on the edges of this activity, developing my ideas about the generation of inflation in a small open economy ('By George' said the uncles, 'do they pay you to do that?'). With Graeme Thompson and Ken Mahar I 'explained' the decisions of the Arbitration Commission, as partly based on movements in inflation, partly based on increases in productivity and partly (and controversially) based on a direct effect of the state of the balance of payments. This 'endogenized' a vital link in the RBA model's chain of causation, including a direct link to the external part of the economy.

It was about this time that a senior bank bureaucrat asked me (in Bill Norton's absence) to use the model to show the effect of a 10% rise in the price of imports. I argued the toss about the relevance of this to anything important and got told to do the exercise anyway, 'I'll show the ignorant bastard' I swore. The simple exercise he had asked for showed a minor effect of imported inflation, as he had expected (I did not know it then but there was a debate raging as to whether the exchange rate should upvalued). Jim Henderson helped me jury-rig the model, including the controversial new wage equation and an endogenous money supply feeding into inflationary expectations, and this produced a much stronger result.

I do not know if my alternative formulation was used in the policy debate, but I submitted a paper to the 1973 Adelaide conference of economists. On the evening before my presentation Chris Higgins of the Treasury came to my room. He explained that it was his job to demolish my paper tomorrow but he thought it was only fair to warn me first and give me the chance to prepare my defence. This was typical of Chris, and also of Treasury, who in my experience always played hard but fair. (Although I will record a time when they declined to play.)

Our confrontation went according to plan and the following day the headline in the Australian Financial Review said something like: 'Treasury Reserve Bank Split on inflation.' My thesis was that inflation was largely imported, while the Treasury line was that it was due largely to 'wage push'.

It was heady stuff, and about three years later in London Chris was good enough to say that Treasury had come to believe that I had got it right. The academics were both harder to convince and less generous in their attribution when subsequent studies reached the same conclusion. (However, at least this time the Uncles were a bit impressed, as they were all in the 'wage push' school.)

To the LSE

The work on inflation gave me a running start at the LSE. Harry Johnson became my thesis supervisor, and arranged for me to give the paper at staff seminars in both LSE and at the University of Chicago. My Ph.D. was on money and the open economy, and this time I used UK data from 1880 to 1970 to construct 'Keynesian' and 'Monetarist' models of the UK economy, each with only 12 equations. A great moment came when a fellow student Henry Kierzkowski and I saw how to combine the Archibald and Lipsey monetary model with the standard two-sector trade model to produce an integrated model. The technical assistance of Dr Clifford Wymer provided crucial input, and Cliff himself was a totally dedicated and inspirational co-supervisor. Inspiration was also derived from the Inflation workshop at Manchester University, especially from David Laidler and Michael Parkin.

A key construct in my UK models was the notion of 'monetary disequilibrium' - the gap between long run money demand and money supply. This construct 'worked well' in my UK model, in the second generation RBA model built later at the Reserve Bank using Clifford Wymer's pathbreaking programs and his direct input and in a model of the Italian economy on which I later worked at the University of Rome. It is a construct that neatly bridges the policy model in which money is determined 'exogenously' with Friedman's version in which money is demand determined. A change in money supply creates monetary disequilibrium but after all the various adjustments have taken place the economy returns to equilibrium with people holding neither excess or deficient money balances. (See 'Money, Prices and Output. An Integrative Essay', Kredit und Kapital, 1975 for a fuller exposition.)

So far at least the idea has never caught on among mainstream economists. I sometimes console myself that it may be like Mendel's experiments with peas, destined to lie unrecognised for many years.

Towards the end of my time at the LSE I received a call from a friend who was both a recognised monetary economist and a bit of a leftie. 'I've been asked to go to Paris to see Dr Cairns about the Reserve Bank' he said. 'What do you think?' I said that he should accept the trip but not the job as Governor which had been hinted at by Doctor Jim's staffer. On the following Monday, my friend called to say that when he got to Paris he was seen by one Junie Marosi, Dr Jim having been recalled, and, as it happened, sacked. Clearly things were hotting up and it was time to get back to the main game.

Back to the RBA

My return to the Bank more or less coincided with the supply crisis although before that Governor Jock Phillips retired. The government was said to be trying to appoint their own man until the last moment and the scuttlebutt had it that Harry Knight went home on the Friday night of Jock's retirement not knowing if he had a job to go to on Monday. In the event, Harry got the job and handled his term calmly and well but with plenty of the traditional central banker's reserve. Like a former Governor of the Bank of England, his utterances tended to be gnomic and journalists such as Paddy McGuinness had lots of fun explaining what the Bank or Harry himself really meant. He invited the Campbell committee to 'tease my views out' and he repeated St Augustine's advice on becoming pure but not too quickly.

Throughout this time my heart was still with the party of the battlers (as I saw the ALP) although the rigorous thinkers of Chicago and the LSE had moved my head a long way to the right. I argued ineffectually within the RBA during the supply crisis that the Bank should fund the budget and I was outraged when the Governor General sacked the Whitlam government. At the subsequent election I voted with my head for the Liberals in the House and with my heart for Labor in the Senate.

It was a traumatic time for a lot of people. Like many others I believe that the manner of Malcolm Fraser's accession to power poisoned his Prime Ministership and destroyed the possibility of vital policy reform.

During the Fraser years I worked initially on policy research. I built on my work at LSE to produce what I called 'A minimal Model of the Australian Economy', with the dedicated help of a cadre of young economists including Warwick McKibbin, Carolyn Moses and Rob Trevor. Clifford Wymer visited to install his advanced estimation and simulation programs and provided unstinting help with both technical and analytic matters.

The RBII model, as it came to be called, had only 30 equations and a lot of strong monetary and international linkages. It was estimated with Wymer's 'full information maximum liklihood' techniques, then (and probably still) the most advanced available. At a conference to review the model I was gratified when John Helliwell, himself a master builder of the earlier kind of model, said generously that in its scope and ability to explain things it was 'more nearly maximal than minimal'.

The RBII model was used to analyse the effects of controlling inflation by controlling growth of the money supply. The model, as well as the usual theoretical analysis, showed the necessity of having a flexible exchange rate and flexible interest rates if money and inflation were to be controlled. Harry Knight had me give these messages to the Bank's board and skilfully wound me up to provide a more radical message when the initial presentation was too tame.

Gradually Harry drew me into more practical policy work, including a stint in the Bank's International department. Here I was for a time in charge of managing Australia's foreign currency resources. Checks and balances surrounded this job and so there was less risk to Australia's credit rating than I led the Uncles to believe.

Part of the job involved managing the Bank's book of 'forward' currencies, and as this was highly technical and done more or less by rote there was scope for innovation. There was in any case a problem of excessive swings in the forward book and I was asked to find a solution. After a lot of thinking and talking I discovered that the rote rules for adjusting the forward rates meant that gaps opened up between domestic and international interest rates when overseas rates rose or fell. After a lot of hard talking I persuaded Harry and others that the answer to our problem was to move the forward rate much more aggressively when overseas rates moved. When this approach was put into place the forward book quickly moved into balance where it remained, for all I know to this day.

The effect of this minor administrative reform was of course to throw more pressure on the 'spot' rates for foreign currencies. Another part of my job was to provide advice each day on the movement in Australia's spot exchanges, set in those distant days by a 'troika' of ministers advised by a parallel troika of officials. I was an adviser to someone who advised the Bank's chief adviser, and I used to joke that on a good day I could influence the forth-decimal place. (Although the 'forward' rate project gave me a lot of indirect influence which no one really understood.)

Anyway, a day came when all the advisers in the line ahead of me were going to be in the air at the time the exchange rate had to be set. The night before I had been drilled in all the possible permutations and combination of events and the proper response in each case. The overnight news was benign and I was feeling comfortable at 9.15 am the next morning as the rate was set for release at 9.30 sharp in line with standard procedures. At 9.16 a shaken youth came into my room. 'What's the problem?' I asked. 'Mr Reagan's been shot' the youth replied. 'Is he dead?' I asked. 'Apparently not,' the youth replied, 'but no one knows how bad he is.'

I sipped my coffee, suppressing the tendency to tell the youth that the President was not a bad person. 'What has New Zealand done?' I asked. 'They did not open their market' the lad replied, 'What about Japan?' I asked (my grip on time zones being imperfect.) 'They open in an hour.' the youth replied, 'but they'll probably take a lead from us.' 'By the way, it's 9.25' he added helpfully. I asked for a moment to think. I suddenly understood what John Harper was saying when he introduced us to type I and type 2 errors. 'We'll open' I said, 'if you're sure he's not dead.'

I was relieved when at 10.30 our time the Japanese opened their market, and it was announced that the President was out of danger. So far as I can recall no one said 'Well done' and in fact I doubt that anything was said at all. Perhaps I acted too rashly, despite the endorsement from the Bank of Japan.

In my debates with my seniors the role of speculation in the 'crawling peg' system of exchange rate management was frequently mentioned. Sir Harold Knight's view was simple and direct: 'We need to behave predictably and without trying to out-think market participents' was his obiter dicta. It was similar to his reason for regular meetings with bank CEOs and (at my level) bank economists. We needed to know these people well so that in a crisis, such as a failing bank, we would have very clear ideas about the people we were dealing with.

It was soon after this that I was transferred back to the Research department, and shortly after that that Austin Holmes returned from Canberra where he had worked firstly for the Whitlam government and then as an adviser to Malcolm Fraser. He was full of frank advice about how to change policy, although he was at heart a pessimist. His valedictory point of view was that economists in government existed mostly to stop the really crappy schemes dreamed up by incompetent politicians and amateur advisers. He was, I thought, even at the time unduly seared by the unusual incompetence of the Whitlam government, as well as the youth spent battling the elements on a marginal wheat farm in WA. Austin believed that Whitlam's greatest weakness was that 'he could not tell a million from a billion.'

Austin was determined to draw me more fully into practical policy, and gave me a lot of scope. He said on my efforts to build economic models: "If a thing is not worth doing, its not worth doing well." Before long I had been made Head of Research and Austin became a full time adviser, where he continued to exercise his sardonic pessimism from the cross benches. In the middle 1980s we achieved the introduction of monetary 'projections' and gradually got the rate of inflation down from the horrendous heights achieved by Whitlam. We contributed to the proceedings of the Campbell committee and greatly welcomed its findings. That its introduction was delayed until the Hawke Labor government is a great historic irony, and a pungent comment on the lost opportunities of the Fraser government.

The biggest challenge in what was a disappointing time for reformers was to predict the scale of the 1982 recession. A key task of course for Research department was to predict the economic cycle, and we had a lot of fun on 'IDC's' with economists from Treasury and Prime Minister and Cabinet. But by late 1981 things were looking ominous. I received a call from a former colleague Phillip Norman, who by then was running his family's stationary business in Melbourne. 'Pete I thought you should know that something is happening in the economy. Inventories are piling up, and people have stopped paying their bills. It's looking pretty awful.'

This immediately reminded me of 1960 and I got our 'liaison' department to dig harder. That Christmas I was travelling to Melbourne and decided to go via Canberra to talk to Ted Evans outside normal channels and without the usual supporting cast. Ted was worried too, and in his case it was a large wage claim that was the major focus of concern. We agreed to turn up the heat after the holiday break and for my part I got the research department forecasts radically revised to predict a severe recession in which the rate of unemployment increased to a postwar record of 9%. The forecasters were reluctant to go too far and I had to be directive. 'Double every change' I instructed, 'then add some for good measure.'

The resulting forecast shocked just about everyone, but the eventual outcome was a peak unemployment rate of 10.4% As an economist at James Capel in 1990 I used the same technique (in this case, lacking access to models or Treasury economists, I spoke to Australia's leading insolvency experts) to predict a recession so severe as to amount almost to depression, but by then no-one in the 'official family' was listening. I did try to repeat Philip Norman's earlier performance by offering a summary of what the accountants were saying in letters to Chris Higgins and Ian Macfarlane.

Malcolm Fraser's futile dash for growth failed to alleviate the situation in 1982 but left the incoming Labor government with a monstrous budget deficit, about the same in billions as the unemployment rate had been in percentages, as I recall. (Perhaps Malcolm had problems with numbers too, I reflected ruefully.) Prime Minister Hawke broke the drought, produced recovery in the world economy and generally encouraged Australians to spend. The net result was a stunning recovery, and part of the psychology was “The Summit”, a brilliant piece of economic theatre that only a formerly hard-drinking Rhodes scholar trained in part by his time on the Reserve Bank Board could have devised.

The Hawke-Keating government introduced many important economic reforms. The ANU economist Ross Garnaut has been rightly acknowledged for his major contribution, but I also believe that the Reserve Bank and its combination of powerful research and market savvy was also important.

I was heavily involved as the Bank's chief 'Sherpa' at the summit, and a major achievement - an outcome mandated by Prime Minister Hawke - was to have it agreed by all Sherpas that higher wages meant higher unemployment and vice-versa. Since the parties included the ACTU as well as natural conservatives such as Treasury and the RBA, this was no mean feat. The model used for the summit projections was old fashioned, incomplete and 'Keynesian' in its focus on income/expenditure linkages, and the Sherpas spent far too little time in considering either microeconomic reform or possible capital market problems. I had a mild warning about the latter issue inserted into the final summit document and sat back to enjoy the theatre.

One other significant matter is worth recording. Representatives from the Melbourne Institute among the sherpas had argued for even more fiscal expansion than the excessive amount already in the pipeline, in what was a significant distraction to the whole proceedings. To its credit, even the ACTU resisted the siren song of the big spenders of other people's money. At the end of the technical proceedings the Melbourne Institute team withdrew with something of a flourish. 'We'll go back to Victoria to show you how it's done' their chief declared in ringing tones. The result, of course, was the near bankrupting of the state.

The election of Labor had coincided with a standard currency crisis. In the week leading up to the election approximately $3B left the country and over the weekend of the election the inevitable currency devaluation (10% as I recall) occurred. In the following week almost $3B flowed back into Australia, a two way tide that earned the speculators a cool $300M. As the debate about currency management hotted up I constantly asked Treasurer Keating whether a Labor government wanted speculators to have such easy pickings at the taxpayers' expense.

Treasurer Keating picked up on this point, which I believe was a crucial reason for the acceptance of the case to float the currency in 1983. In fact Keating generalised the argument in the debate on financial deregulation generally. 'What have the banks ever done for us?' he would ask his caucus colleagues. 'Let's deregulate the joint and give 'em hell.' I frequently argued at the time that financial deregulation would be a wedge driven into an ossified economy and that it eventually would lead to deregulation of even the labour market.

At a crucial time in the discussions leading up to the float Bob Johnston returned a bit discouraged from a cabinet meeting in Canberra. "John Stone says to float would be a mistake. How do I counter this?" I was a bit sick of all the shilly-sallying. "Simply counter-assert, Bob. He can't prove his case and we have".

Next time Bob returned from Canberra it was to report that the currency was to be floated and we were going to abolish the exchange control department that day - no ifs or buts were allowed from the cautious men who ran that department or supervised its activities. This was Bob Johnston's finest hour.

While Bob when he retired spoke generously about my contribution to his time as governor, must record there were bad days as well. I was his chief speech-writer. A typical speech had 20 drafts, and in my view the third draft was usually the best.

Sadly Bob was not sufficiently confident to grapple calmly with difficult economic issues. I was disappointed that he ran the Bank's executive committee by promoting division in which older 'Advisors' beat up younger men with heavy responsibilities, and as the only relatively young policy chief I was the chief victim. Of course I was a fighter and coped fairly well but the cumulative effects were wearing. Austin Holmes whose job I had taken decided this was my fault rather than his, and he became a hostile force both at meetings of the Executive committee and more insidiously with the staff of Research Department.

In the late 1970s, with Treasury backing, 'monetary projections were introduced. This idea I supported, but while still a full-time researcher I could claim no influence except research papers supporting the core idea. These 'projections' fell well short of hard commitments, and in the RBA Deputy-governor Don Sanders was a constant reminder of 'Goodhart's Law, that any supposed empirical relationship would break down. When it became obvious thanks to the work of andrew Mohl that financial deregulation meant the latest 'projection' would be greatly overshot I recommended we replace it by a 'check list'.

It would have been far better to introduce an inflation target, but no-one in Treasury or the RBA suggested this at the time. I later pointed out that even if we had proposed this then, 'Goodhart's Law' would have been invoked to kill the idea. 'I won't cop that' Dan Sanders, now head of the commonwealth Bank, wrote me with passion. The fact that the RBA had to be brought kicking and sneering to the table when an inflation target was adopted several years later rather supports my idea. Still, I now regret I did not propose this eminently sensible solution at the time.

I will recount just one more story on this occasion. Several years have passed. The economy has recovered strongly, and I have been brooding for some time about problems with the balance of payments. In this brooding I am fully supported by Austin Holmes, who provoked me into getting someone in Research to construct a table of Australia's international debt.

After about 6 months of debate within the Bank I gained permission to publish a table showing the growth, which is still modest, in this debt. ('By George' said the remaining Uncle, '6 months for a table!') The table attracts mild interest, but a fuse has been laid and the economy sees that it is alight. My brooding intensifies. I decide to do something completely outside the usual frame, to construct some 5-year forecasts. Existing models, even the RBII model, is inadequate for the task but the existing team, which includes as key members Chris Ryan, Jeff Carmichael and Malcolm Edey do the necessary technical work with flair and authority. We feed reasonable projections for external growth, for commodity prices and world interest rates and run the simulation. Lo and behold, the model predicts an explosion of debt, a massive fall in the value of the Australian dollar, the resurgence of inflation and another large rise in the rate of unemployment! My fellow members of the policy committee of the Reserve are not amused. 'Deliberate pessimism' is the cry, and another 6-month debate began. (This use of the RBII model, like my earlier use of the RBI model, was an answer to Austin Holmes on the futility of such exercises.)

Eventually it was agreed to send our controversial projections to the Treasurer, carefully marked 'Draft' with a covering letter which fell well short of endorsement. In short order we are summoned to Canberra where, as the poet wrote, 'All hell broke loose'. We met in a large meeting room in Treasury. The Treasury team sat opposite the Bank team and its members are careful to avoid eye contact. The Bank team sat beside me on the other side of the table, but seemed to be leaning away from me in both directions. The Treasurer is at the head of the table with his advisers and is obviously pretty steamed up. He has extensively annotated the paper and quickly launches into a tirade of abuse mixed with analysis.

'Deliberately pessimistic' is the core of his criticism, though some of the abuse would have been fun to listen to if I hadn't been the chief beneficiary. We debate the paper for several hours, and I gradually score points. Jeff Carmichael also fought hard for the Research department case, and towards the end Euwan Waterman says from the far end of the Treasury bench that it is possible that I had a point. Bernie Fraser at that stage risked some eye contact, and the rest of the Reserve's team sat slightly more vertically, though I can recall no positive leaning in my direction.

Bob Johnstone reported to the Executive committee of the RBA that I gave as good as I got, which was perhaps my biggest mistake.

A week or so later the Commonwealth Statistician struck a blow for our cause, when he released a record current account deficit of $1.3 Bn. 'Don't gloat' was Bob Johnston's advice as we went back to see a more subdued Treasurer. Some little time later Paul Keating made his famous 'banana republic' comment on the John Laws show and set the stage for some serious policy action. The excessive budget deficit was turned into a surplus and the ACTU copped another cut in real wages. These were the main policy recommendations in our paper for the Treasurer, which he initially described as 'impossible.' The Bank's own policy contribution was a judicious touch on the monetary brakes, and this set of actions added up to one of the most successful bits of economic policy action yet seen in Australia's economic history.

In the wake of this episode I was systematically cut out of the policy loop, a response that puzzled me at the time. But in thinking about his time in government, I have sometimes wondered if there is not a revealing pattern. Paul Keating started out with a number of competent and courageous policy advisers but these gradually dropped away. I wonder at the causes of this, and whether they do not point to some curious quirk in the Keating psyche, amounting, perhaps, to a fatal flaw.

My wife Elizabeth had her own (country-based) views about the public sector. To her the choice was between being an academic and making real money in the professions or in business. When the headhunter called, I was ready to respond. He offered a salary four times the one I was earning as a key economic policy adviser. This seemed ridiculous at the time, and still does, but who was I to argue with the verdict of the market?

In my final meeting with Bob Johnston he asked me to tell him my new salary, which I did. A few weeks later Paul Keating announced exactly that amount as the governor's new salary. Since then RBA salaries have risen steadily until the governor earns an annual salary of over a million. As the principal architect of that new trend I reflect ruefully that none of my former staffers who have benefitted so fulsomely have ever thanked me. Apparently I was too tough as a boss, but I feel certain young women and men on the rise are managed more gently than I was.

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