Glenn Stevens: The Inaugural Warren Hogan Memorial Lecture
Text of The Inaugural Warren Hogan Memorial Lecture by Mr Glenn Stevens, Governor of
the Reserve Bank of Australia, at the School of Economics, University of Sydney, Sydney,
8 December 2011.
* * *
It is a very great pleasure, as a former student of Professor Warren Hogan, to give this
lecture in his memory. Thank you to the Hogan family, many of whom are here this evening,
and to the School of Economics at the University of Sydney for giving me this honour.
Before recounting one or two personal reminiscences, it is appropriate to say something
about his life. Many fascinating details of it are revealed in the interview with John Lodewijks,
and the eulogy by Tony Aspromourgos, both fittingly published in the Economic Record.1
Warren Pat Hogan was born in Papakura, just south of Auckland, New Zealand, in 1929. He
completed his undergraduate and Master's education at Auckland University College, where
he was taught by Colin Simkin, who later was also at the University of Sydney. He married
Ialene, a fellow student in the same faculty, in 1952. Hence it is not altogether surprising that
Hogan's children seemed drawn to economics. Four of the five children, and several of the
grandchildren, have degrees in economics.
After gaining early work experience at the Reserve Bank of New Zealand, Hogan, with a
young family in tow, came to Australia in the mid 1950s, where he gained a PhD from the
Australian National University in 1959, his research being on growth theory. His supervisor
for that work was Trevor Swan, one of Australia's most renowned theoretical economists
(and subsequently a member of the Reserve Bank Board). Ivor Pearce, with whom he would
later collaborate in writing about international finance, was a close confidant and mentor.
Among the early fruit of this work, as recounted in the Lodewijks interview, is that Hogan
uncovered an error in a celebrated paper by Robert Solow. This led to an exchange between
Hogan and the future Nobel Prize winner in the Review of Economics and Statistics.2 Heady
stuff indeed for a young graduate student from the antipodes.
Hogan rose quickly through the ranks at Newcastle University College in the 1960s. But it
was as Professor of Economics at the University of Sydney, for 30 years from 1968, that
Hogan came to more prominence. Joined by Simkin, he sought to lift the technical standard
of economics at the faculty, including by putting more emphasis on quantitative techniques.
This met a good deal of resistance as part of the broader debates about how economics
should be taught. By the time I was a student here from 1976 on, both sides seemed to have
dug into the trenches and the dispute had been bitter.3
None of that stopped Warren Hogan from grappling with significant issues in economics or
economic policy. In fact, Hogan's professional life shows an active mind always pursuing
some important question. In a career that produced over 150 articles, books and chapters of
books and many shorter publications, he ranged broadly. As early as 1958 he was producing
articles examining the rise of new financial intermediaries outside the regulated banking
system - a theme about which we were still hearing in the 1980s, and one which should
resonate today in light of the attention being given to "shadow banks" and the expansion of
the weight and width of the global regulatory footprint currently under way.4 Hogan retained
an interest in both financial regulation and deregulation throughout his career, and married
this with a nuanced understanding of the behaviour of financial players in their appetite for
risk.
Hogan also worked on issues of development in the emerging world, wages, immigration and
transport. He served as economic adviser to one Federal Treasurer (Lynch) and as a director
of various companies, most notably serving on Westpac's board for 15 years, including
through the period of deregulation and subsequent tumult. In his later years he conducted a
major review of pricing in aged care. He also served in numerous capacities over the years in
various university administrative positions and on other committees in the broader
community. His was a full life indeed.
It was in my third year at Sydney University that I think I first encountered Professor Hogan.
This would have been in 1978. More than three decades after I sat in afternoon seminars
conducted by him, the memories of his general style are clearer than the things he actually
said. He was usually dressed in a suit - which would have been much more unusual for an
academic in the late 1970s than it is now. The reason was perhaps that he had been in the
city earlier in the day as he was active in dealing with practical policy issues and had links
with the business world. On days when there might have been a nice business lunch, there
was a certain relaxed expansiveness to his demeanour. He spoke often without notes on
whatever economic topic we were covering, and as he spoke he would take the various coins
from his pocket and arrange them into small piles on the table. We wondered what
subconscious portfolio balance idea might have been behind that behaviour. Warren often
had a somewhat elliptical way of saying things - you had to listen carefully to get what he
may have really been saying, and sometimes you weren't sure you had understood correctly.
As I reflect now on this characteristic, I wonder whether he missed a calling as a central
banker!
He certainly had built up contacts in the central banking world, as an occasional visitor to the
BIS, where he was on very good terms with the late Palle Schelde Andersen, a renowned
BIS economist and student of the international economy and financial system. I assume that
their acquaintance was made in the late 1970s, when Andersen visited the University of
Sydney for a period, funded by a grant from the Reserve Bank.5
One Hogan paper of that era that really struck a chord with me then - I have always recalled
its title - was about the issue of revisions to economic statistics. It was entitled "How Do We
Know Where We Are Going, When We Don't Know Where We Have Been, Let Alone Where
We Are?".6 These days the study of revisions to data is an art in itself (though the quality of
national accounts data is better than it was in the 1970s). Central banks put huge effort into
what has come to be called "nowcasting" - that is, working out what the national accounts
probably will, or should, say about the current quarter in three or four months' time when they
are released. Some central banks actually "backcast" the recent past, deciding their own
version of GDP, not necessarily the same as the one published by the statisticians, in effect
foreshadowing revisions to come.7 The RBA has not gone to that extent, though of course we
have seen certain difficulties in assessing the current pace of underlying inflation in our own
country over recent months, with reasonably significant revisions to some - as far back as
1978.
But the work on which I wish to focus for a brief period tonight is the book Hogan co-authored
with Ivor Pearce entitled The Incredible Eurodollar.8 Published first in 1982, with subsequent
editions published in 1983 and 1984, this fascinating little book sought to explain the
workings of the Eurodollar market and the institutions which operated in it. In the 1970s - the
dataset on which Hogan and Pearce based their work - the Eurodollar markets were an
exotic new development, spawned by a period of international financial turmoil and
innovation, some of which was in response to regulation.
The post-World War II compact known as the Bretton Woods system had held for about 20 to
25 years. This involved a US dollar standard, under which countries fixed, and occasionally
adjusted, their exchange rates to the US dollar; the dollar was fixed to gold at US$35 per
ounce; private capital flows were limited in scope; and official flows made major
contributions, via the IMF, to international adjustment. But by the late 1960s and early 1970s,
this arrangement had come under severe strain as private capital flows began to increase in
size and US policymakers found they could not live with the constraints of the system. In a
sequence of events, including the break of the link with gold and the decision by key
countries to allow their currencies to float against the dollar, the system broke down. The
result was a system in which exchange rates between the then major currencies have
floated, with occasional efforts at management, ever since.
The Eurodollar Market was in essence a pool of obligations issued by banks outside the
US jurisdiction but denominated in dollars. It grew rapidly, apparently unconstrained by
regulation conducted on a national basis (as all regulation was, and largely still is). It was
part of a large increase in cross-border financing activity by internationally active banks.
When Hogan and Pearce published their third edition in 1984, the stock of cross-border
assets held by BIS reporting banks was about US$2 trillion. Today, it is around
US$32 trillion.
In the early 1980s, much of the talk about the Eurodollar Market was couched in terms of
whether Eurodollar deposits should be added to measures of the money stock, which were
the height of economic fashion at the time. As you will recall, this was the period in which the
US Federal Reserve targeted monetary aggregates explicitly and in which weekly monetary
aggregates data were scrutinised closely for signs about the likely direction of US interest
rates. One can see this background quite clearly in Hogan and Pearce's little book, which
has lots of discussion about whether Eurodollar deposits are "money" (they thought not) or
just "debt" (they thought so).
It was only a few years later that most countries gave up the effort to define "money" and to
conduct their policy discussion in terms of money aggregates, instead going back to the
former model of setting a short-term interest rate. It is interesting, though, that in recent years
the "zero lower bound" for nominal interest rates, which as students we would have been
taught about as "the liquidity trap", is no longer a curiosum in the textbook from a bygone era,
but has actually been binding in several major countries. One implication, among others, has
been that calibrating monetary policy in terms of monetary quantities has come back into
vogue in some places - this time with the relevant central banks consciously seeking to
increase the size of their balance sheets. Whether the relationship between "money" and
nominal GDP or prices has become any more reliable than it was 25 years ago, when it was
found too fluid to be useful for policy purposes, is not clear.
But if the language in Hogan and Pearce's early 1980s work is, perhaps, a product of its
times, some of the observations are astute, and there are some quite prescient insights.
To begin with, Hogan and Pearce note that the activities of Eurocurrency markets - and we
could generalise this to cross-border private financing generally - lessened the pressure on
countries to adjust to current account imbalances, especially on the deficit side. This could be
seen as good - allowing capital to flow more efficiently to the locations offering the highest
risk-adjusted return. Or it could be worrying: the markets giving a nation more rope, so to
speak, by allowing current account balances to become larger and more persistent than they
would otherwise. Remember that at the time they wrote, current account positions had rarely
been more than a few percentage points of GDP for any length of time, at least since 1945.
The analysis of the mythical planet Htrae, with three countries Surplusia, Deficitia and
Balancia, with respective currencies Surps, Defs and Bals, focuses on the operation of
markets and, importantly, the role of financial institutions as intermediaries between savers in
one country and borrowers in another. In the language of more recent times, financial
institutions are key to the dynamics of so-called "global imbalances". Indeed, Hogan and
Pearce state, rather bluntly: "Financial intermediaries live upon imbalances".9 At one level
that is obvious - financial intermediaries or markets exist to transfer resources from savers to
borrowers (and back again), which is to say that an imbalance between saving and
investment at the level of an individual household or firm in the economy is matched against
an equivalent imbalance of opposite sign in some other firm or household. The deeper sense
in which this "thriving" takes place in an international setting is that savers in one country
lend their money to borrowers in another jurisdiction, about whom they know next to nothing,
but feel safe in doing so because what they hold directly is an obligation of a large,
wellknown, globally active bank, assumed to be safe.
But as Hogan and Pearce point out, a European entity raising dollars to fund a balance sheet
does not have automatic access to a lender of dollars of last resort in the event that market
conditions change. It is therefore exposed to serious funding risk in a way that does not
occur in purely local currency operations. The average "Eurobank" in the early 1980s had
access to marks or francs - today euros - or pounds from its national central bank, but it
could not be assumed that in times of stress these currencies could necessarily easily be
swapped for dollars. In fact, this very phenomenon was at the heart of the crisis that began to
unfold in 2007. It was in Europe, where banks had, and still have, a structural need for dollar
borrowing to fund US dollar denominated assets, that the market strains first appeared in
August 2007. As the crisis intensified, the need for access to central bank funding in dollars
required a number of central banks to enter into swap arrangements with the US Federal
Reserve so their domestic banks could borrow US dollars secured by local currency
collateral. European banks were by far the largest users of these facilities - about
US$400 billion was accessed via the ECB and other central banks in Europe at the peak in
December 2008.
Of course, it is also in Europe that we have seen the epicentre of the most recent stage of
the crisis. In some other respects, today's problems are a little different, and perhaps more
complex, from those of three years ago. They arise from cross-border lending within a
currency area that has a single money but very divergent experiences in terms of fiscal
discipline and productivity, and that lacks a well-developed capacity for intra-area transfers
- which is being built as we speak. Nonetheless, dollar funding for European banks has
again tightened up and the swap lines among major central banks have again been activated
to assist. This is presumably designed to slow the speed of European bank deleveraging of
dollar assets that would otherwise be forced to occur.
Lots of people claim to have predicted the crisis, though I doubt that Warren Hogan, were he
here, would claim that he and Ivor Pearce foresaw it in all its dimensions almost 30 years
ago. I think they would perhaps claim that their saga of Htrae, where international
crossborder financing ultimately produced a crisis, contained many relevant insights. I doubt that
they fully appreciated the role that the financial institutions of the leading deficit country - the
United States - would play in creating risk and transferring it elsewhere. In their story, the
key institutions were those of the country of Balancia, where the international accounts
initially were balanced. I think they would have expected the response of major central banks
to the crisis to have resulted in more inflation than it has, so far. That may be a reflection of
the inflationary times in which they were writing - when it seemed almost inconceivable that
deflationary problems akin to the 1930s could re-emerge. The example of Japan, where
there has been deflation for well over a decade, had not yet occurred in 1982. Of course,
they might just have expected the inflation still to be coming. They would not be alone in that
view.
It is certain though that Hogan would have been watching all these developments with close
interest. He would have been recognising certain things that he could have broadly
predicted, and I suspect he would have said so with that very dry turn of phrase he had. He
would also, surely, have been observing things that would have surprised him, and he would
have been thinking about how his view of the world needed revision. He would have been
pondering the future of the international financial system.
In that vein, I shall use the remainder of the time this evening to make a few observations in
that area.
The first is that there is an extensive program of regulatory reform under way. In an
international setting potentially the most far-reaching is the set of proposals recently
endorsed at the G-20 summit to mitigate the problems posed by institutions that are too big
to fail at an international level, otherwise known as Globally Systemically Important Financial
Institutions, or G-SIFIs. Some 29 individual banks have been identified as fitting the criteria to
be labelled G-SIFIs at present, though the list is not a fixed one: banks can enter and leave it
over time. There will, in due course, be a framework for globally systemic insurance
companies with parallel criteria. The intention of the policy is to make the failure of such
entities less likely by requiring additional capital, and to make the consequences of failure
less dramatic by developing better tools to resolve entities that have failed or are on the point
of failure. The latter, in particular, is a very ambitious undertaking and contains some
potentially far-reaching components - such as the ability to "bail in" certain creditors to an
institution on the point of failure, effectively turning them into shareholders, so as to lessen
the likelihood that taxpayers will be called upon in such a situation. To make it work would
require considerable co-operation across jurisdictions at moments where everyone's instinct
is to protect creditors and counterparties in their own jurisdiction.
I don't know what Hogan would have made of this. I suspect he would be wondering
whether, if regulatory actions bind on one group of institutions, the behaviour in question
would end up migrating to other, less-regulated places. This possibility is understood by the
international regulatory community, which also has a regulatory agenda for "shadow
banking". This is actually a critical point. I would offer the observation that, if we can get
through the next year or so without a major crisis and successfully implement the various
reforms - which might both be big "ifs" - the next financial crisis may not occur in the same
sorts of institutions as last time (or this time), but in different ones. It could well occur in
institutions or markets that do not as yet exist.
The key thing in avoiding disastrous crises in the future is less the specifics of regulation or
resolution - as important as these are - than having a clear understanding of the nature and
extent of risk-taking behaviour, in all its potential dimensions and locations. On my reading of
Hogan's work, I believe he would have shared this view. Put in the simplest of terms, we
might ask: where are financiers apparently making easy money? In what area of risk-taking
are the profits large or expected to be large? There is a good chance that it is there that,
given enough time, the likelihood of excesses is greatest.
In Hogan and Pearce's book, financial institutions and their behaviour were seen as central
to the build-up of imbalances. But they are in one sense merely facilitating flows of capital
that are reflective of other phenomena, resulting from the collective behaviour of the actors in
surplus and deficit countries. So in contemplating the future of the international financial
system, reforming the regulation of financial institutions, and understanding their behaviour,
will be key, but it will be of equal importance to understand the underlying behaviour of the
entities in the real economies.
The role of official capital flows, in particular, is one element of the post-crisis world that
seems to be becoming quite prominent. Indeed, perhaps one of the most striking features of
the international financial system is the size of official reserve assets that have been
accumulated by what Hogan and Pearce would have labelled "Surplusia" - the countries that
have run persistent current account surpluses. In the early 1970s, the accumulation of US
dollars by surplus countries made for problems of monetary control in some large reserve
holders like West Germany. When the Bretton Woods system finally broke down in 1973,
total foreign reserves of all countries amounted to about 21⁄2 per cent of annual global GDP.
West Germany's reserves were about 7 per cent of West German GDP. Today, total
reserves in the world amount to the equivalent of about 15 per cent of global GDP, up from
10 per cent only five years ago. China's reserves are close to 50 per cent of Chinese GDP.
Many other Asian countries have equivalent ratios around 30 per cent or more; while, in Latin
America, foreign exchange reserve holdings are typically in the 10-15 per cent range.10
There are numerous reasons behind this build up. The very high levels of energy prices in
recent years have pushed up the reserves of oil producers, and this accumulation may have
some logic as they seek to spread over a long period the income gains accruing from a finite
resource. The reserves of many Asian countries have risen to much higher levels after the
1997 crisis, as a form of insurance against capital flow reversal. Indeed the IMF advised this
after the crisis, advice that has been taken to heart perhaps a little more than the Fund
intended.
One can understand the desire for self-insurance, and particularly as those Asian countries
that had IMF programs in the late 1990s felt the conditions for mutual insurance - through
the IMF - were very onerous. But the self-insurance provided by large holdings of reserves is
costly, especially in the low interest rate environment we see in the major countries. Trillions
of dollars and euros held on behalf of the citizens of countries across Asia (and elsewhere)
are earning meagre returns and subject to increasing sovereign risk. This cost of
selfinsurance is therefore becoming increasingly apparent, a trend that will surely continue as,
inevitably, Asian productivity levels continue to increase relative to the Western countries and
their real exchange rates rise.
Large centres of high saving with portfolios that are overweight in foreign assets whose
return is low and whose value is highly likely to go down, measured in the currencies of the
holders, amounts to something of a problem. Attempts by those holders to exit this position
quickly would be, to say the least, highly disruptive. They know that and that is why they do
not attempt it, though there is a degree of diversification under way. To paraphrase the old
line, if I owe you a few billion, I may have a problem. If I owe you a trillion or two, you may
have a problem every bit as big as mine.
So there is a very long-term issue of portfolio re-balancing to be addressed here as well as
one of structural realignment of national price levels (i.e. real exchange rates). At the same
time though, there are increasing calls for the emerging economies with large surpluses and
high reserve holdings to play a part in assisting Western economies facing budgetary and
banking sector problems. With the balance sheets of many Western sovereigns already
under pressure, there is hope for contributions from large reserve holders - they, after all,
are the ones with the cash.
It has to be observed, surely, that pressing reserve-heavy emerging economies to lend into
structures designed to smooth adjustment processes in the advanced world amounts to a
call to perpetuate, to a fair extent and for at least a bit longer, some of the very "imbalances"
that so many have lamented for so long. What people are really saying is that they want to
move only quite slowly away from the current constellation of resource flows and prices that,
in other discussions, have been seen as constituting the problem.
That may well be the best approach. But it is observable that large reserve holding countries
are already getting uncomfortable with their degree of exposures to major Western
governments. Hence, any offers of assistance are likely to be made with a careful eye to risk
minimisation. This is likely to mean they will prefer to operate through international
institutions, such as the IMF. Alternatively, they may prefer to take hard assets in return for
their cash, rather than financial obligations, which, in turn, could easily raise the social and
political tension level. At the very least, managing all this over the next decade will require
level-headed analysis, far-sighted decisions on the part of national policymakers and a
degree of international co-operation much greater than we usually see.
Moreover, there will be some very important questions to be confronted. Not least among
them will be that, with the relative economic weight of the emerging world rising quickly, and
a rise in their financial weight flowing from their high rates of capital accumulation and
increasing creditor status, they will expect an increased role in global financial governance as
a condition of accepting more obligations to contribute to the global common good. The
willingness of the established, post-war leadership countries to cede a degree of status and
control to the emerging world will need to increase at the same speed as the emerging
countries' willingness to grasp and accept their rising responsibilities. Will this occur? It is
hard to judge. Much will depend on whether the various parties have the same general ideas
about the purpose of the international monetary system. That is, at this point anyway, not
clear.
Another thing we might see is a certain tendency towards the financial repression that was a
feature of the post-war world in which Warren Hogan first studied economics. A legacy of the
1930s was a much tighter regulatory regime for banks, elements of which lasted for decades.
A legacy of the 1940s was a very large stock of government debt. Debt to GDP ratios were
well into triple digits for countries like the United Kingdom and the United States (and for
Australia). Yet from the 1950s through to the 1970s, debt-servicing dynamics were kept
within manageable bounds. The rapid growth in economic output in the long post-war boom,
which was aided by demographics and productivity performance, was a major help. But also
contributing was a combination of central banks holding down long-term interest rates at
government direction, and banks and other entities being forced to hold government debt.
And of course, at the end of that boom, a period of unanticipated high inflation played a role
in lowering debt to GDP ratios.
In the current era, however, the rapid output growth will likely occur in the countries that don't
have much government debt but do have productivity catch-up working for them, while in
many of the countries that have a lot of debt the demographics will be going the wrong way.
It is therefore conceivable that with slow-growing countries feeling pressed for solutions,
regulatory actions might have certain attractions. Given this, and with many emerging
countries having mixed feelings about many aspects of free financial markets anyway, it is
conceivable that the current trend towards more assertive and intrusive financial regulation -
which is occurring for very understandable reasons - will end up going much further than
contemplated at present. The potential for an outcome that eventually involves significant
inflation is also obvious.
I have only touched the surface of many of these issues. As I said earlier, I cannot know
what Warren Hogan would have thought of them, or whether he would agree with my views. I
am sure, though, that he would have thought these matters worthy of further discussion and
that he would have contributed to that discussion. Hopefully, I will have succeeded in
stimulating some further discussion tonight.
Once again, thank you to the University, and to the Hogan family, for permitting me this
honour. I hope this marks the start of a successful series of lectures.
References
Aspromourgos, T (2010), "Warren Pat Hogan, 1929-2009", Economic Record, Volume 86,
Number 273, pp 289-93.
Cunningham, A and C Jeffery (2007), "Extracting a Better Signal from Uncertain Data", Bank
of England Quarterly Bulletin, Volume 47, Number 3, pp 364-75.
Hogan, WP (1958a), "Technical Progress and Production Functions", Review of Economics
and Statistics, Volume 40, Number 4, pp 407-11.
Hogan, WP (1958b), "The Banking System and the New Financial Intermediaries", The
Australian Quarterly, December, pp 17-29.
Hogan, WP (1978), "How Do We Know Where We Are Going, When We Don't Know Where
We Have Been, Let Alone Where We Are?", Economic Society of Australia and New
Zealand, NSW Branch General Meeting, October.
Hogan, WP (1979a), "Eurofinancing: Currency, Loans and Bonds", Working Papers in
Economics, University of Sydney, Number 33.
Hogan, WP (1979b), "Controlling Eurofinance Markets", Working Papers in Economics,
University of Sydney, Number 36.
Hogan, WP and I Pearce (1982), "The Incredible Eurodollar", George Allen & Unwin, London.
Hogan, WP and I Pearce (1984), "The Incredible Eurodollar, or Why the World's Monetary
System is Collapsing", 3rd edition, Unwin Paperbacks, London.
Lodewijks, J (2007), "A Conversation with Warren Hogan", Economic Record, Volume 83,
Number 263, pp 446-60.
Pearce, I (1980), "The Incredible Eurodollar", Discussion Papers in Economics and
Econometrics, University of Southampton, Number 8006.
Solow, R (1958), "Technical Progress and Production Functions: Reply", Review of
Economics and Statistics, Volume 40, Number 4, pp 411-13.