Glenn Stevens: The Australian economy - then and now
Address by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the Inaugural
Faculty of Economics and Business Alumni Dinner, University of Sydney, Sydney, 15 May
2008.
I thank Clare Noone for assistance.
* * *
Chancellor, Vice-Chancellor, Deputy Chancellor, Deputy Vice-Chancellors, Dean of the
Faculty of Economics and Business, distinguished guests, ladies and gentlemen.
I think the last time I was in this Hall may have been for my graduation. If not then, it was
probably for an examination. Either way, tonight's occasion is far more convivial and I thank
the University for the invitation.
One of my classmates of old suggested that a good topic for this conversation might be a
comparison of the Australian economy of the late 1970s, when we were students, with that of
today. The more I thought about that suggestion, the better it seemed and so that
comparison is exactly what I propose to offer. In the moment-by-moment focus on the
economic data, and all the wiggles and ticks up and down of this indicator or that, we can
often neglect to stand back and look at the big picture. So let us rectify that for the next
25 minutes or so.
The approach is to use charts and tables to compare two decades - the 1970s and the
2000s - so as to offer some perspectives on how things have changed and, perhaps, on how
they are similar.
Economic structure
Table 1 gives a comparison of the structure of the economy by industry then and now. The
two most striking changes are the decline in the share of output provided by manufacturing,
and the rise in financial and business services. This trend has occurred in all developed
countries. Agriculture is smaller than it was then, though 2007 was a drought year, which
affects that comparison. Communication services have become more important. (The mobile
phone was not invented in 1977, of course. What did students do between lectures, I
wonder?) Mining is larger today, though not by much.
Table 1: Structure of Australia's Economy
Share of GDP (per cent)
1977 2007
Manufacturing 16.4 10.1
Financial, property and business services 12.4 19.5
Wholesale and retail trade 11.1 10.3
Education, health and community services 9.2 10.0
Utilities and transport 6.6 6.8
Construction 6.3 6.8
Mining 5.9 6.8
Government administration and defence 4.9 3.9
Rural 3.7 2.1
Communication services 0.7 2.7
Other 22.9 21.2
Source: ABS
Beyond these shifts, not all that much has changed at the broad structural level. Australia
even 30 years ago had quite a substantial services sector, and still does.
But the opening up of Australia to international trade, as a result of the policies of tariff reform
and product market liberalisation since the mid 1980s, has been a significant change
(Graph 1). The change in our trade patterns has been substantial (Table 2). In the late
1970s, over 60 per cent of Australia's trade was conducted with the United States, major
European countries and Japan. While these countries continue to be important to Australia
today, their share of Australia's trade has fallen by a third and is now eclipsed by our trade
with China and emerging east Asia. This feature reflects the growing importance of China
and emerging east Asia more generally - together, their share of global GDP has trebled to
almost 18 per cent since the end of the 1970s.
Graph 1
Trade Share of Australian GDP*
Percentage
% %
45 45
40 40
35 35
30 30
25 25
20 20
1960 1970 1980 1990 2000 2010
* Exports plus imports in ratio to GDP.
Source: ABS
Table 2: External Environment
Share of Australia's merchandise trade (per cent)
1977 2007
Japan 26.9 14.3
Major European countries 20.5 16.3
United States 14.4 9.9
Other east Asia 8.5 29.5
China 1.3 14.3
Notes: Data for financial years. UK included in Major European countries.
Source: ABS
External influences on Australia are also reflected in our terms of trade (Graph 2). A key
feature of the early 1970s was the spike in our terms of trade as supply disturbances pushed
up world commodity prices. Today, rising commodity prices are again a feature of the global
economy. However, this time around, much of the rise in our terms of trade appears likely to
be more sustained, resting as it does on the demand arising from the long-term emergence
of large economies like China and India.
The more open economy today also means we are more exposed to these forces. In
addition, the opening of the capital account in the early 1980s has led to a degree of
integration of the Australian financial system with the world in a way which offers a much
larger choice set to savers and investors.
Graph 2
Terms of Trade
2005/06 = 100
Index Index
120 120 120 120
100 100 100 100
80 80 80 80
60 60 60 60
1975 1982 1989 1996 2003 2010
Sources: ABS; RBA
Macroeconomic trends
My next set of comparisons is of major macroeconomic aggregates. The first is growth in real
non-farm GDP. I use non-farm GDP simply because farm GDP can be highly volatile due to
droughts and floods. That, as rural producers know only too well, has been a constant
feature of the Australian experience.
On average, growth in the economy in the two periods under review was very similar, at
about 3.4 per cent (Graph 3). But there was a marked change in the middle of the 1970s.
After a number of years of very rapid growth, the economy encountered much more adverse
circumstances from 1974 onwards. That was true for most countries, though Australia's
relative performance on some metrics deteriorated. From 1975 to 1979, the average growth
rate was a full percentage point lower than in the period from 1971 to 1974. The period was
also noteworthy for the close proximity of two episodes of cyclical weakness, in 1974/75 and
1977. There was also a recession in the early 1980s.
Graph 3
Real Non-Farm GDP Growth*
Then and now; year-ended
%
%
8 8
6 6
4.0%
2.9%
4 4
2 2
0 0
-2 -2
1971 1973 1975 1977 1979
% %
8 8
6 6
3.4%
4 4
2 2
0 0
-2 -2
2001 2003 2005 2007 2009
* Average annual growth based on HP-filtered trend.
Sources: ABS; RBA
The current decade so far has seen average growth of 3.4 per cent, though the next couple
of years will probably see growth noticeably lower than that. What is quite noticeable from
the chart is the relative stability of growth in recent years, something that was a feature of the
second half of the 1990s as well. This pattern was observed in many economies over the
same period. Of course, the 1970s makes for a flattering benchmark in that it was the most
unstable period in macroeconomic terms in the entire post-War period, so even average
performance will look better than that. But, in fact, the period since the mid 1990s has been
very stable by any standard. Those who have looked into this in detail have posited several
possible contributing factors, including better macroeconomic policy frameworks, a wide
range of microeconomic reforms in labour and product markets, and luck.
The weak growth of the latter 1970s was associated with an upward trend in unemployment
(Graph 4). From a low of 2 per cent in the early 1970s, it rose to about 5 per cent in the
mid1970s recession, and then drifted higher over the remaining part of the decade. Similar
trends were observed abroad. The big rise in real wages in the mid 1970s, part of which was
exogenously imposed as a result of government policy at the time, also had a fair bit to do
with higher unemployment.
Graph 4
Unemployment Rate
Then and now
% %
6 6
4 4
2 2
0 0
1971 1973 1975 1977 1979
% %
6 6
4 4
2 2
0 0
2001 2003 2005 2007 2009
Source: ABS
The trend in unemployment in the most recent decade has generally been downward.
Following a rise of a percentage point in the economic slowdown in 2001, it has fallen to the
lowest levels since the mid 1970s. The long expansion, with occasional temporary pauses,
has done a lot to foster lower unemployment. But the changes in labour market
arrangements over the past 20 years or so have also been very important. Indeed, I would
argue that they are a key contributor, not least because they have facilitated the longer
length of economic expansions.
The difference in inflation rates between the two decades is particularly striking (Graph 5).
Being a central banker I suppose I would say that, but I think it is too easy to forget the
corrosive effect that high inflation had on the economy in those days. Until the mid 1960s,
Australia had been a low-inflation country. The seeds of the 1970s inflation were sown in the
latter part of the 1960s, they took root in the early 1970s and then the events of the early and
mid 1970s pushed inflation up steeply. From the end of 1970 to the end of 1979, the average
rise in the CPI was 10.7 per cent a year, which meant that the value of money fell by 60 per
cent over that period. The peak inflation rate in any one year was 17.6 per cent, and the
lowest achieved was just under 5 per cent.
Graph 5
CPI Inflation
Then and now; year-ended percentage change
% %
15 15
10.7%
10 10
5 5
0 0
1971 1973 1975 1977 1979
% %
15 15
10 10
3.0%
5 5
0 0
2001 2003 2005 2007 2009
Source: ABS
In contrast, the current decade shows a pretty flat line for inflation when put on the same
scale as the 1970s. We still have our cyclical ups and downs, but the average rate has been
3.0 per cent since the beginning of 2001. Even with the recent surge in consumer prices
taking the inflation rate to a bit over 4 per cent, things are not like they were in the 1970s.
That's just as well, of course, because with entrenched high inflation would come lots of
distortions and wasted resources as people in the economy adjusted their behaviour to live
with high inflation. One of the adjustments would be that savers would demand higher
nominal interest rates, higher than the ones we currently see, to part with their money.
So the period between about 1973 and 1983, when the economists of my generation were
studying and then getting their first jobs as economists, was a pretty poor one for
macroeconomic performance. The past decade, in contrast, has been much better. Once
again, a more favourable international environment has been a factor there, but so have
better economic policies. Let me turn, then, to economic policies.
Macroeconomic policies
four
When we were students, we were taught about the arms of economic policy, which were
fiscal, monetary, exchange rate and wages policies. We still have fiscal and monetary policy,
about which I will say something in a moment. But by the early 1980s, enough people had
accepted that you could not really choose the exchange rate and monetary policy settings
independently. You either allowed financial conditions to adjust to whatever was dictated by
a given exchange rate, or you set domestic financial conditions according to the needs of the
economy and let the exchange rate adjust to that. The decision to float the exchange rate,
made in 1983, was a decision to do the latter. Of course, there have been subsequent
occasions when, via intervention, we have sought to influence the exchange rate, but they
have been confined to fairly brief periods and have become less frequent as time has
passed.
Wages policy was important for the wrong reasons in the 1970s, in that government pushed
up minimum wages too quickly for a while. In the 1980s, wages policies negotiated in the
form of the Prices and Incomes Accord between the Hawke/Keating Governments and the
ACTU were effective in containing wages growth and allowing some restoration of the share
of national income accruing to profits. This did a lot to generate employment and growth. It
seems unlikely that such a degree of influence over wages as an instrument of
macroeconomic policy will return. These days, policies over industrial matters are more
structural in nature, aimed at making arrangements in the labour market reasonably flexible,
balancing economic efficiency and fairness, and providing a safety net for the lowest paid.
So that leaves monetary and fiscal policy. When I was a student, furious debates had long
been boiling away in the halls of academia over questions like: does money matter? Was
monetary or fiscal policy more effective as a stabilisation tool? Was the apparent trade-off
between inflation and unemployment, which appeared so tantalisingly in the data, something
that could be exploited systematically, or would it prove ephemeral? Was discretion best in
the conduct of monetary policy, or should some sort of rule be employed?
The 1970s and early 1980s provided important real data and experience in the resolution of
these questions. Friedman and Phelps had already long argued that there was no long-run
trade-off and that attempts to reduce unemployment below some structural level by
accepting higher inflation would simply result in accelerating inflation and no lasting gain on
unemployment. The 1970s seemed to demonstrate that this was right. More strident
derivatives of the Chicago tradition, however, which insisted that there was not even any
short-term trade-off, were found to be wide of the mark.
Money did seem to matter, since the big rise in inflation in the 1970s had been preceded by a
large increase in money growth. A lot of people not only accepted that monetary quantities
were the key thing to look at, but concluded that central banks had failed to control them, so
that some sort of step away from unconstrained discretion towards monetary rules was
advisable. As a result, targets for those quantities were adopted, including in Australia. That
was the language of discussion when I was a student and when I first started work at the
Reserve Bank in 1980.1
These days, we have inflation targeting, an arrangement that provides a measure of
constrained discretion to the central bank within a medium-term framework. It emphasises
the control of inflation over time, but does not seek to fine-tune inflation over short periods.
That allows a reasonable accommodation for trends in economic activity and employment
over periods of a year or two, about which the Reserve Bank is required to have concern by
its Charter as well as by common sense, but preserves the value of the currency over the
long run. In the language of trade-offs, this system accepts there is a short-term
growth/inflation trade-off, but also accepts there is no long-term one. Inflation targeting does
not ignore financial quantities, but does not elevate them to the status of an intermediate
target and does not see them as an instrument. Inflation targeting is not perfect and, on
occasion, still leaves policy-makers with some quite difficult decisions to make. It is, however,
the best system that has been devised as yet.
The fiscal debate of the 1970s was dominated by the budget deficits of the period, and the
need to reduce them. On contemporary figuring, the Commonwealth's budget deficit reached
about 4-5 per cent of GDP in the middle years of the decade. Using figures comparable to
those in use today, which measure the underlying cash balance of the Commonwealth
general government sector, the deficits of the mid 1970s amounted to only about 2 per cent
of GDP (Graph 6). But until 1974, the Australian general government sector had recorded
more or less continual significant surpluses, so the turn to deficit in 1975/76, for the first time
since the early 1950s, was substantial and, at the time, quite controversial. Reducing the
deficit in the sluggish economy of the late 1970s was hard. Deficits grew much larger in the
recessions of the early 1980s and early 1990s.
Graph 6
Commonwealth Government Budget Balance
Underlying cash balance, per cent of GDP
%
%
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
1970/71 1972/73 1974/75 1976/77 1978/79
% %
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
2000/01 2002/03 2004/05 2006/07 2008/09
Sources: ABS; Treasury
Since 1997/98, in contrast, the federal budget has been in surplus continually, apart from a
very small deficit in one year. The government's net debt has been retired. Gross debt on
issue is maintained at a small size in order to facilitate a functioning bond market so as to
allow efficient risk pricing more generally. As with monetary policy, there is a medium-term
framework for fiscal policy emphasising balance over the business cycle. There is much less
inclination today than there once was to use fiscal policy as a counter-cyclical stabilisation
tool.
Significant fiscal challenges in the long-term include health spending and responding to
population ageing, as the very important work by officers of the Australian Treasury has
made clear. But there would be very few countries, if any, which would not envy Australia's
fiscal position. The capacity to respond, if need be, to developments in the future is virtually
without peer. This seems light years from the situation in the late 1970s.
I have said little here about the changes to microeconomic policies, which do so much to
determine the economy's supply-side responsiveness. That is because my field of interest
and expertise is in the macro sphere. But these microeconomic changes were equally as
important as the macro ones, maybe even more important. I mentioned the change in labour
market policy, but this was accompanied by a host of other changes to factor markets (like
financial liberalisation) and product markets (tariff reform, competition policies and so on). It
is actually these policies that have done most to improve the living standards of Australians.
The contrast between the Australian economy of 1977 - heavily regulated, suffering poor
productivity growth, sheltering behind high barriers to foreign competition - and the much
more open and productive one of today is striking.
The teaching of economics
The final comparison I offer is in the teaching of economics. Of course I do not sit in lectures
or tutorials, so I am unable to judge whether or not the face-to-face teaching has changed
since the late 1970s. But one interesting exercise is to compare the text books used today
with those in the past.2 I understand that at the University of Sydney a popular text is the
Australian Edition of Ben Bernanke's Principles of Macroeconomics (co-authored with
Robert Frank, with the Australian edition adapted by Nilss Olekans). When I studied
macroeconomics in 1977, the text in use was Fred R. Glahe's Macroeconomics, published in
1973.
One interesting difference that is obvious immediately is the less formal layout. I think it is fair
to describe Glahe's text as rather formidable and austere, and perhaps not a particularly
inviting read. In contrast, the book by Bernanke et al is much more welcoming, challenging
students with thought-provoking questions and illustrations on how economic theory relates
to tangible real world events.3 Perhaps the less formal presentation style says something
about how society has changed over the past three decades, but I think it also reflects an
economic force at work, and that is competition. There is a proliferation of new
macroeconomic textbooks, many by highly regarded economists. This competition seems to
have spurred authors to try to produce the most appealing text for students and lecturers in
order to capture market share. To the extent that these texts may help to cultivate an interest
in economics, this has been a positive development.
On content, both include discussion of the "money multiplier", as an introduction to the theory
of fractional reserve banking. I suppose students have to learn that, and it is easy to teach,
but most practitioners find it to be a pretty unsatisfactory description of how the monetary and
credit system actually works. In large part, this is because it ignores the role of financial
prices in the process.4 Bernanke et al do, however, discuss some aspects of financial
markets, and I note that in the most recent US edition of the text this has expanded to cover
asset prices, the diversification of risk and the role financial markets play in ensuring savings
are allocated to their most productive uses. In the shadow of the current dislocation in global
financial markets, this is obviously a pretty valuable addition to the curriculum. Ben Bernanke
has also, of course, made major contributions to academic literature in these areas over the
years.
The 1970s book was full of discussion about monetarists versus Keynesians, and of
shortrun and long-run Phillips curves. The later book confines them to a section called Lessons
from the
Past.5 Whereas Glahe's 1970s text makes extensive use of the IS-LM framework
from Sir John Hicks' exposition of "Mr Keynes and the Classics" in the 1930s, IS-LM per se
does not rate a mention in the modern undergraduate text book.
But perhaps the biggest difference is in the treatment of the open economy, exchange rates
and so on. In Glahe's 1973 book, the analysis is conducted entirely in a closed economy
setting. The term "exchange rate" is not one that appears in the index. Today, even the
United States sees itself as an open economy, and the Bernanke et al book treats the issue
carefully and even contains some international comparisons of data.
What do we take from all that? At the risk of offering a set of sweeping generalisations, I
would observe, first, that some of the things which so preoccupied us in the 1970s about the
role of monetary policy, the nature of trade-offs, both short and long term, between inflation
and growth or unemployment have been regarded by the mainstream of the profession as
pretty much settled. At least, they have been as settled as things ever get. It is to be hoped,
of course, that we do not have to re-learn those lessons, which is why I have been making
the case to resist inflation even though that is not comfortable or convenient in the short run.
Second, the theory and practice of mainstream macroeconomics has become more
international in focus. This trend will surely continue, in response to the course of events. Not
only have the effects of bad loans to American home buyers had reverberations much further
afield, but the rapidly growing size of the emerging world is affecting economic activity and
prices far beyond their own borders. I would hazard a guess that the textbooks of 30 years
from now (if we are still using books) will devote large slabs of material to that emergence,
and to how well the "old industrial countries" adjusted to it. They will also, no doubt, cover the
economics of climate change and its abatement at some length.
Conclusion
That is my thumb-nail sketch of the Australian economy, and economics generally, then and
now. Of course, this is not a very rigorous treatment and many things have been omitted. But
this is supposed to be a relaxed occasion.
Re-reading some of the material, and looking at the data, takes one back. I should not
mention many particular names, but Professor Warren Hogan, still active in developing policy
thinking, was one figure of importance. Peter Groenewegen's courses in the History of
Economic Thought were memorable, as was the course in Economic Classics that he taught
with Colin Simkin. Those courses introduced me and others to Smith, Ricardo and Wicksell,
as well as to the then-standard fare of Keynesians and monetarists. And who among the
honours classes of the late 1970s will forget the aroma of coffee brewing in the corner of
Prof Simkin's study, his desk clouded in cigarette smoke, the students sitting, terrified,
waiting for the interrogation ahead about the use of Kakutani's fixed point theorem to prove
the existence of general equilibrium? Some things are harder than monetary policy!
It was an enormous privilege to attend the University of Sydney, to have made some very
good friends (whom I have still), and to have encountered some remarkable teachers who
introduced us to the study of economics. It was marvellous to have been a part, however
small and fleeting, of the life of this place three decades ago, and a great honour to have
resumed that association in this way tonight.
References
Principles of Macroeconomics
Bernanke, B. and R. Frank (2007), (3rd edition),
McGrawHill/Irwin, Boston.
Bernanke, B., N. Olekalns and R. Frank (2005), Principles of Macroeconomics
(1st Australian edition), McGraw-Hill, Australia.
Glahe, F. (1973), Macroeconomics Theory and Policy, Harcourt, Brace Jovanovich, New
York.
Wicksell, K. (1898), Geldzins und Güterpreise: Eine Untersuchung über die den Tauschwert
des Geldes bestimmenden Ursachen. Jena: Gustav Fischer (tr., 1936: Interest and Prices: A
Study of the Causes Regulating the Value of
Money, London: Macmillan).