The Joe Walker Podcast - The Silent Hero Of The Australian Economy - Ian Macfarlane

Episode Date: January 15, 2020

Ian Macfarlane was Governor of the Reserve Bank of Australia from 1996 to 2006. He is the author of The Search For Stability and Ten...See omnystudio.com/listener for privacy information.

You're listening to the Jolly Swagman Podcast. Here's your host, Joe Walker. Hello there, ladies and gentlemen, boys and girls, swagmen and swagettes. Welcome back to the show. 2020 is shaping up to be a huge year for the podcast, and it's great to have you along for the ride. It is a singular privilege to share with you this conversation with Ian McFarlane. From 1996 to 2006, Ian was the governor of the Reserve Bank of Australia, Australia's central bank. He's an economist by training, and prior to joining the Reserve Bank in 1979, he worked at Monash University, Oxford University, and the OECD in Paris. Former Prime Minister John Howard wrote in his autobiography that, quote, McFarlane was the standout economic official in the lifetime of my government.

His advice and sense of balance was far superior to that of anybody else who provided economic advice to us, end quote. As governor of the Reserve Bank, Ian presided over the beginning of the longest expansion in Australia's history, at least since reasonable records have been kept. Australia's run of unbroken economic growth was in its 15th year when Ian retired, and it's now, of course, in its 29th year. Ian's governorship stands out to me for one reason in particular, and that is that Australia was the first and only OECD nation to raise interest rates in the early 2000s, a period in which inflation was relatively low. The reason, Ian tells me in this conversation, was to see off a bubble in the

residential property market that he could see building like a thundercloud on the horizon. When the global financial crisis struck two years after the end of Ian's tenure at the bank, many countries around the world were brought to their knees by highly leveraged housing bubbles. Economists refer to this period as the Great Recession. Australia escaped it. The Rudd government is lauded for acting to prevent an Australian recession, but of course its task was made so much easier by the fact that Ian had leaned against the wind years earlier. Had he not, Australia may well have had a housing bubble that was too big to not fail, and gone the way of

Ireland, Spain and the United States. For this reason, I regard Ian as a silent hero of the Australian economy, and I mean silent hero in the sense that Nassim Taleb uses the phrase in the prologue to his book The Black Swan. He describes a silent hero as someone who helps us avoid disaster, but who we nonetheless fail to properly appreciate because we have no counterfactual. Now, in his retirement, Ian has turned his hand to writing biography. He has a new book of short biographical essays titled 10 Remarkable Australians. The subjects of his book have been mostly forgotten by the public. None of them is a household name like Bradman, James Cook, or Ned Kelly, but each lived a

life that was exciting, eclectic and extraordinary. Ian was very kind to give me a copy of the book and I enjoyed it immensely. During the first 20 minutes of this podcast conversation, recorded at Ian's home on the 12th of January 2020, Ian and I discussed 10 Remarkable Australians, delving into the lives of three of his characters in particular. We then embark on an economics masterclass that sees us travel through the boom housing bubble of the 2000s, including the time Ian sent junior Reserve Bank staff to attend property spruiker seminars, the global financial crisis and whether anyone saw it coming, the Melbourne land bubble, and much, much more. I hope you enjoy this frank, varied, and insightful conversation as much as I did.

Ian McFarlane, thank you so much for joining me. It's a pleasure. I'm very excited to speak with you about this charming, very handsome book published in November, Ten Remarkable Australians, your first foray into biography. That's correct. I think you began thinking about writing this in 2003. published in November, 10 Remarkable Australians, your first foray into biography. That's correct. I think you began thinking about writing this in 2003. You started writing around 2016. That's correct.

And then it was published at the end of last year. So, we're going to talk about 10 Remarkable Australians. We're also going to talk about economics. Of course, you were the Governor of the Reserve Bank of Australia from 1996 to 2006. And I wanted to tell you how much I enjoyed our first two conversations here in your living room where we are today. So, I'm very excited we also get to share some of your economic views with our listeners because I think you're an important voice. And as you know, I regard you as the silent hero of the Australian economy. And we can talk about why that is later.

But first, let's begin with this book. It contains 10 short biographical essays of 10 remarkable yet relatively unheard of Australians. And I was very surprised reading through the list of the 10 because not one of the names I'm embarrassed to admit I recognized. Tell me why you wrote the book? People often ask that question and they ask another question, how did you choose the ten? There's the same answer to both questions. I've always been a reader of history and biography, principally international, but also some Australian. And I kept coming up against this experience of reading a book by an author who wasn't Australian about some events outside Australia. And at some point in the story, a very unusual Australian would pop up, and someone who I'd never heard of either.

And I started looking into these people. Now, the first example of this was when I was reading a biography of the poet Rupert Brooke, and Frederick Septimus Kelly, an Australian, appeared. Now, Kelly was introduced as a great sportsman, which he was. He'd won the Diamond Skulls at Henley Regatta three times and an Olympic gold medal in rowing. But it turned out that that was only the second string to his bow.

He was first and foremost a classical music composer and concert pianist who had given concerts by himself and with the Sydney Symphony Orchestra, the London Symphony Orchestra. I thought, what an amazing man. I ought to learn more about him. And the second occasion, I was reading a book about early attempts to climb Mount Everest by a Canadian author.

And it turned out that the best mountaineer in the world in the 1920s was an Australian, again, who I'd never heard of, George Finch. He climbed higher than anyone had ever climbed before in one of the attempts on everest and by the way he was also professor of chemistry and a fellow of the royal society and his relationship with the famous australian actor peter finch was an intriguing one so that also set me going and then i think the third step towards the book which convinced me that I should write a book was when I came across Harry Hawker now I'd heard of the Hawker aircraft company who'd built all these famous planes like the Hawker Hurricane which was the workhorse of the Royal Air Force in the Second World War um the Hawker Harrier jump jet uh anyone

who knows anything about aviation or even if you don't you would have heard of the Hawker Harrier jump jet. Anyone who knows anything about aviation, or even if you don't, you would have heard of the Hawker Aircraft Company. But who was Hawker? It turns out he was a kid from Melbourne who left school at 14, went to England, became a test pilot, and he was a brilliant, intuitive engineer, designer, and helped design some of the important planes in the first world war particularly the swap with camel but the other thing that made his story interesting

is that he was the first person to attempt to fly across the atlantic no one had ever attempted a flight that long over water before and he didn't make it he only got halfway but survived that was an amazing story in itself so you can see how these things kept piling up and I decided that when I've got the time I'll put these together into a book. And I found the time in 2016 and enjoyed the research very much and enjoyed the writing. And so now we have this book, which I'm very pleased to have completed and particularly pleased to see what a wonderful job

of actually printing and publishing the small publisher I used did. Yeah, well, it's a beautiful little book and the foreword is written by the great Australian historian Geoffrey Blaney, your friend. Did Geoffrey give you any advice when it came to writing history and biography? He was extremely helpful. He's the one person who is actually new. He didn't know all the 10 names but he knew nearly all of them. No, he was very, very helpful and encouraging. Yeah. Put me in touch with a few people, and I'm very thankful to him.

The first time we caught up and we were talking about the state of Australian biography, whether there's too much of it or too little, and you told me what I thought was quite a hilarious statistic about the biographies of big-name Australians that have been published since the year 2000. What was that? Well, it was in reference to the fact that the big commercial publishing houses told me my book would not be commercially viable. Because the Australians weren't famous. Well, because the people were unknown. Yeah. And I've got to accept that they're, I think they're wrong,

but they had a right to make a judgment. But one of the problems with this way of thinking is that just as Hollywood studios are criticised for doing remakes of old films our big publishing houses just do just churn out the same biographies again and again so I did a little bit of research and I found that since 2000 there have been 13 biographies of Ned Kelly and I think 11 of Don Bradman and 10 of Captain Cook. So I think this is a bit disappointing that it's the same stuff over and over again. It would be nice if they're a little more adventurous like me. Yeah. So let's jump into a couple of the characters who appear in your book. We'll start with Harry Hawker, who you mentioned.

Now, he's fascinating because, as you said, the Hawker Aircraft Company was founded in his name. The Battle of Britain was largely fought on Britain's part with Hawker Hurricane fighters. And yet, he came from very humble beginnings and moreover died at the age of 32. So how did this humble Australian come to have his name imprinted on an aircraft company? Yeah, it is interesting that a man with so little education could become both a brilliant pilot and more interestingly, a brilliant aeronautical designer. And we can only put it down to the fact that he just had

enormous intuitive ability. Right from the early years, he built his own motorbikes. He didn't buy a motorbike. He built a motorbike. In fact, he built the engine. In fact, he even built an engine just to run your own workshop. He'd done all this by the time he was 21 or 22. And so when he went to England,

he didn't have any trouble finding a job as a mechanic. Then he became a test pilot for the Sopwith Company. And, of course, a lot of the design of an aeroplane is actually done by the test pilot in the Sopwith company. And, of course, a lot of the design of an aeroplane is actually done by the test pilot in the air. There's only so much of it you can do on the ground. So more and more he was suggesting design changes and became, according to Sopwith, he was really mainly responsible for the design

of their planes in the First World War. So the main British plane in the First World War was a swap with Camel, which a lot of people may have heard of. That's what Biggles flew. And it was one of those that chopped down the Red Baron. And Hawker was probably the main designer, not the only one. They were a team of people. And so it was quite remarkable.

He arrived in England in 1912 as a sort of nobody. And by the end of the war, he was an extremely successful test pilot, designer, in fact, even a wealthy businessman. It was all achieved in about 10 years. And then he did his transatlantic flight and became a popular hero. Banjo Patterson wrote a story about him, a poem about him. And then he died shortly after in an airplane crash, of course. The other character, I think perhaps one of the most interesting characters

in the book is George Morrison. Tell us about George. Yeah, a lot of people find George the most colourful character. He's better known as Chinese Morrison or Morrison of Peking, because in the second half of his life, he lived in China and became a very, very influential man. But right at the beginning of his life it's just as interesting this is a man who when he was 17 walked from Geelong to Adelaide around the coast at the age of 20 this is even more amazing he walked from the Gulf of Carpentaria to Melbourne and he did all sorts of other remarkable things.

By the time he was 21, visited Vanuatu to investigate the Kanaka trade, decided to make an attempt to explore inland New Guinea, the result of which he got speared twice, once through the face and once through the stomach. Ended up having to go to Edinburgh to get himself repaired. He still had splinters in him. Yeah, he had splinters in him, that's right.

And whilst he was there, he entered Edinburgh University and qualified as a doctor. But he was never really going to be happy being a doctor. He had a desperate desire to travel. And then the next thing he did of interest, after having spent a few years as a doctor, was to walk from Shanghai to Rangoon and write a book about it. And the book was quite successful. And on the strength of that book, he was offered the position

as the Times correspondent in Peking, as it was called then. And he turned that into a position of great influence. He didn't speak Mandarin. What he was an expert on was not actually what was happening in purely Chinese terms, but he was an expert on was not actually what was happening in purely Chinese terms, but he was an expert on all the machinations going on between the British, the Russians, the French, the Japanese, the Germans, as they were carving little bits out of China. And he became the sort of the authority in the world on what was going on there.

If you wanted to know what's happening in china morrison was the man he contacted so he had people like the president of america consulting him the emperor of japan consulting him uh and then in the other thing that happened during his time there was the boxer rebellion and of course he was a very brave man as you could gather and he was in the front line defending the Boxer Rebellion, during which he got shot. So during his career, he managed to get himself speared and shot. So he obviously had a very adventurous life. And he was a witty man who wrote a very interesting diary,

which I quote from time to time. Where did you go to find the diary? The diary's in the New South Wales State Library. A daily diary? Yes, and it starts from when he was about 17 or 18. Yeah. And he also wrote a huge number of letters, including regular letters to his mother virtually for his whole life.

Yeah. The other character I wanted to ask you about was frederick kelly he was a pianist and a scholar but not a scholar in the bob hawk sense a scholar in the rowing sense uh tell us about frederick kelly well kelly came from a very wealthy family and he left austral at quite an early age and completed his secondary education at Eton and then won a music scholarship to Balliol College, Oxford. And he lived this sort of idyllic Edwardian life

of a moneyed gentleman, doing his sculling, that was his sporting activity, and more importantly, first and foremost, composing. He was mainly a composer rather than a concert pianist, although he was a concert pianist. And he lived this idyllic life in England with several return trips to Australia, including one trip where he stayed for a year in Australia

and that's where he started his performing career as a professional concert pianist before going back to England and continuing it. The thing that struck me was how many people he knew, from the Prime Minister to various painters, writers, generals. He moved in sort of the higher circles in Edwardian England how did he become familiar with the Asquiths everything went through Balliol College okay it was sort of a network of people at Balliol College Oxford and because the other extraordinary thing about him as soon

as the first world war was declared he just immediately assumed he'd have to serve. Never gave it more than a second's thought. But instead of going to the local recruiting offices, most people would do, he turned up at 10 Downing Street. Yeah. I found the diary entry from that day quite charming. He heads for Downing Street and there's an entry where he came in. Lord Kitchener was just outside the door and Asquith,

who was of course the Prime Minister at the time, puts his head in from a neighbouring room. Anyhow, that is, unfortunately, I suppose as you could see what was going to happen, the thing ends in tragedy. He goes to Gallipoli, survives Gallipoli. And indeed marks himself out as a leader. Yeah, he gets decorated, comes back to England for about nine weeks, resumes his life and then gets sent to the Western Front

which is okay for a while and then at some point he's sent to the Somme and at the Somme. And at the Somme, he and his contingent are asked to go over the top, and they do, and he gets killed. Yeah. It must be the most awful thing that could happen to you that I can conceive of is being in the army in the First World War and being ordered to go over the top and run towards the enemy machine guns and rifles, knowing that your chance of survival is quite low.

Yeah. Was his music popular in its day? No, not really. Right. Well, he was only 35 when he died. Yeah. And his music was starting to be circulated. Yeah.

Before he went into the army. So he was only, he was 33 when he went into the army. It was early in his career. It's being revived now. I've been to concerts where Kelly's music is played in Australia. Did you enjoy the music? I did, yes. I didn't like the vocal stuff.

I didn't like the bit that was accompanied by a soprano, but the purely orchestral stuff I enjoyed very much. Hmm. As you say, he was 33 when he joined the war effort and he had no prior training. He didn't need to serve. He wasn't obligated to, but he chose to out of a sense of duty, we can only assume.

Yes. I found that very touching. There's something that binds in common many of the characters in this book, which is a sense of bravery or courage. Is that a fair statement? Yes, I think they were all... Physically brave. Most of the people in this book, the ones that we've talked about, certainly, were definitely risk takers. They set out, worked out what they wanted to do and how to go.

And several of the others could definitely, in the book, be classified that way too. Yeah. So there's one woman in the book. Have you had many people remark on that fact, why there's not more of an equal gender balance? It's true. People say, why have you only got one woman? Yeah.

And the explanation, of course, is pretty easy. In that era, these people were all born between 1858 and 1888. Very few women would sort of leave and try their luck overseas. Of course, there's one very famous one, Milbaugh, and she's too famous to get in my book. But I looked around searching for women who would fit that and, as I say, there weren't very many. But the first place to look, obviously, is literature because that's where women first made a big mark.

And so I found Henry Handel Richardson, who left Australia at the age of 17, spent 15 years mainly in Germany, also training to be a concert pianist, and then deciding that really she was never going to make it to the top there and turning to literature and moving to England and then living the rest of her life in England, thoroughly continental person until she picked up a pen. And as soon as she picked up a pen, it's the only thing she could really write about was Australia.

So she wrote that huge trilogy, The Fortunes of Richard Marnie, and the lighter work, The Getting of Wisdom, purely Australian books, which I found intriguing because having left at the age of 17, the age of 60, she's still writing about, in some sense, the only things she really identified with, which was Australia. Yeah. I want to ask you one more question about the book as a whole. The question is, what was your historiographical process

when you were writing it? How did you view your role as the historian and the biographer? Well, as I said at the beginning, the only reason I wrote it was I stumbled upon these things which I found to be very interesting. And I didn't set out to build a monument to these 10 people. If that happens, that'd be great, but it's just a byproduct. I wrote about it because I thought it was very interesting. And I thought there'd be enough people out there

who would also find it very interesting. Now, these people were, as I said, well-known, even famous during their lifetime. So the starting point were actually biographies. Most of these people had biographies written of them, and the biographies are out of print by now in most cases. But you can't just trust a biographer, because they tend to fall in love with their subjects. So the main form of research was reading other accounts that involved these people's lives, written by people who weren't their biographer, and trying to put everything into perspective.

And in some cases, in five cases, I was actually able to consult diaries and letters. But I didn't, as I say, i didn't set out with a historical objective i didn't say oh here is a gap that i want to fill i think i have actually filled a gap but that's not what i set out to do i just set out to write these stories because i found that they were interesting and let's talk about economics as i said the first two conversations we've had here at your home were immensely enjoyable to me. And we spoke about financial instability and the Australian housing bubble or the first phase of it in the early 2000s. We spoke about debt i want to begin by asking you just why you i've never asked you this before but why you studied economics in the first place what interested you in it well i suppose i didn't really know what to do when i was at high school once days i wanted to be an automotive engineer

another time i wanted to be an architect uh i was doing a straight maths science sort of thing. I wanted to get away from that. And economics seemed to be somewhere between sciences and humanity. So I was attracted to it. And then when I was doing it, I think there was a huge amount of optimism about economics in the 1960s. And we thought we'd really solved most of the problems because the 50s and 60s were such a period of strong economic growth, low unemployment,

relatively low inflation. And I thought these developed countries like Australia have solved the problem. I'd like to go and get a job at an international organisation and see whether they can fix up the developing countries. The only organizations I'd heard of that did that were the IMF, World Bank, or the UN. So that's the sort of thing I had in my mind. I had four jobs, in a sense, after I finished my undergraduate degree. One in Melbourne at Monash University, a temporary one in Sydney at Monash University. Yeah.

A temporary one in Sydney at the Reserve Bank. I wasn't a member of the permanent staff. I was a consultant. Then I had one at Oxford. And then I had one at OECD in Paris. Now, you attempted to apply for a full-time position at the Reserve Bank back then when you were rejected. Is that right? Yeah.

Do you know why they rejected you? Yeah, they had a test, an attitude test. Attitude or aptitude? Attitude, double T. Right. And they decided I had a bad attitude. Oh, really? Yeah.

What gave you a bad attitude? Because they asked a whole lot of questions and you were meant to, I now know, you were meant to take the least risky answer. You were meant to be a very cautious, risk-averse person. And I answered sometimes the other way, mostly the other way. And so I was rejected. Interesting. When you came back to work at the bank, was that test still around?

Yes, it was. But I wasn't asked to submit it. I came back at a more senior level. I didn't have to submit myself to that test. Did you try and get it abolished? Yes, I did, yes. Were you successful? Well, I'm not sure whether I was personally responsible for getting abolished. Right. I wasn't the only one who had that view. So a few of us decided we'd better get rid of that test.

Now, when you came back to Australia, you're in your early 30s, and you got FOMO about buying a home, didn't you? Did you purchase a home at that time? Yes, I did. It was an awful experience because there was a boom going on. As you know, the Australian housing market doesn't go up in a straight line. There are little periods of boom, and then there are periods where it's flat and stable and then another boom.

There was a boom going on in 1979 when I was looking for a house and it was really an awful experience. You turn up at a house, you've seen the advertisement in the newspaper and you turn up to look at it and told that the first person through had bought it. It was really hectic. Anyhow, that boom continued. I bought the house and the boom continued for another year and a half or so. So I was in this ridiculous position, which I described to several people,

where the increase in the value of the house in my, I don't know, year and a half or two years back in Australia was much greater than the salary I'd earned in two years. Wow. Yeah. And that made me, gave me a lifelong dislike of periods of frenetic house price increase. Why?

Well, having been through that experience, that's why I was always dubious about... But once you got your foot in the door, you got the benefit of the capital gains. And from a purely selfish perspective, that's true. You didn't want other people to go through that. Yeah, I didn't want other people to go through that. That's right. so if you remember well for the first time we caught up we

spoke about the podcast conversation i had with the chicago economist amir sufi he's quite famous for a book he co-authored with atif man called house of debt you listened to the conversation, but you said a lot of these insights about the dangers of household debt or private debt more broadly really became obvious to you back in the late 1980s when Australia went through a classic boom and bust. Just take us back to that time first let you know let's zoom right out paint a picture you know i wasn't i wasn't alive then so sketch australia for me during the 1980s well we had a sudden uh financial deregulation which we probably had to have because the old system wasn't working but with the sudden financial deregulation occurring in an environment where there was still quite high inflationary expectations, we ended up with an asset price boom and bust.

That's the phrase I've always used, asset price boom and bust. Today you would say bubble. The same thing. But at that time it was mainly concentrated in the corporate sector. So we had all these bonds and sc spaces and people gearing up to buy things. And then we had a big collapse at the end in the early 90s during that recession, a big collapse, which not only took down these highly geared speculators, it blew up a significant part of the financial sector.

I mean, two big banks, state-owned banks, State Bank of Victoria, State Bank of South Australia, failed, the biggest credit union, teachers' credit union of Western Australia failed, the second biggest building society, the Pyramid Building Society failed, numerous merchant banks failed. It was a classic boom and bust in asset prices.

Followed by our first real banking crisis since the 1890s. Yes. I mean, the bust part of it. The bust part. Part of it was the only, yeah, the only banking crisis we've had since the 1890s. Two of the big four banks made significant losses but survived. Westpac and ANZ made significant losses but survived.

But as I said, State Bank of Victoria is a very big bank. It was really number five bank and it failed. So I sort of, in some sense, I made my name during that period because I was making speeches pointing out to the asset price boom and bust aspect of the economy when most of the economists were concerned with the balance of payments and foreign debt. And I saw it differently. I saw it as very much boom and bust. And at this time, you were head of research at the Reserve Bank of Australia. Yes, yes. Yeah.

Yes. You published a paper in 1989 that was your kind of first pass at understanding the issue. I think it was called like Debt, Credit and Asset Prices or something like that, wasn't it? I can't remember the title. Yeah, 1989. And then have you subsequently come to revise the views in that? What was your argument in that original paper? Well, I think he's revised my views a bit in the sense that...

Well, what were your views first? Well, there's no doubt that there was an asset price boom and bust, and the asset price boom was going to contribute to the bust. I mean, it was so frenetic that it was going to cause a bust. That part is definitely true. The issue was how much of it was generated from the demand side. People just wanting to buy assets to gear up, you know, the negatively geared mentality.

How much of it came from the demand side and how much of it came from the supply side? Financial deregulation meant that, I think, 17 new banks appeared and umpteen merchant banks. And I think my initial paper concentrated on the demand side, the desire for people to make these capital gains. I think now that the supply side was probably more important, that if you actually suddenly increase the supply of credit,

then the institutions that supply credit have to lend it somewhere. And the only way they can lend it is to go out the risk frontier and start lending to people who really shouldn't be, shouldn't really qualify for being customers. And so I think there's been a bit of a change in the way I interpret that episode now. Right. During the early 1990s,

so the recession we had to have began in, was it September 1990? Around about then, yeah. Ended about September 1991. Yeah. Ended before I was born. Yeah. And in the fog of war, the debate focused on the role of the Reserve Bank in raising rates.

Was that fair criticism? It's true that we did raise rates quite a lot, and it's amazing how high they were, and it's amazing how high they were when the borrowing and lending still continued at 20% rate, I mean, 20% increase per annum in business credit for five years, even though rates were put up. But the issue of, I don't know whether this is what you're getting at,

the issue is who was responsible for getting rates as high as they were? And the answer is the Reserve Bank, the Treasury and the Treasurer Keating. We all agreed that had to be done. There wasn't any disagreement amongst the three entities. And if you see, as I think the popular press did, that the recession was just a policy error, you put up interest rates too much, then at least all three people were

party to it. But if you see the recession as part of this asset price boom and bust, which is the way I see it, and in fact, it is the way Paul Keating saw it when he said the recession we had to have. I mean, once the economy gets so overheated as it did, at some point there's going to be a downturn. And in some ways you could say it would have been worse if we had not put up interest rates

because the boom could have continued even a lot further, in which case the bus would have been bigger. The popular narrative blamed the pilot for overcorrecting, but really the passengers were having a huge party up back and making his life difficult. In that conversation with Amir Sufi, I didn't actually agree with him as much as I let on. I suspect beliefs actually play a larger role

in asset booms and busts than the supply of credit. I think the credit constraints view is a very popular narrative in the economics profession at the moment, which Sufi and Mann have helped make more popular. And it's very seductive because it gives you a straight through line from how does the bubble begin all the way through to how does it end? And then subsequently, why is the recession so bad? Because of what happens to consumer balance sheets. But I think while the credit supply view is strong in explaining why the recession is so bad, I don't think it is as strong in explaining how the bubble begins and ends. I think that's got something more to do with beliefs, what people think about the future,

their optimism, how they react to each other, the interdependence of their beliefs. And that stuff is just crazy hard to model and predict because now we're getting into real complexity. Have you given much thought to beliefs and their role in the formation of speculative bubbles? I'm not sure that I know what we mean here by beliefs. It certainly is true that during the one that I was most interested in, the 1980s asset price boom, there was incredible optimism and there was an assumption that the only way to get ahead was to acquire assets that increase in value.

And there was definitely an assumption that the more debt you had, don't worry about debt because um we still got a fair bit of inflation around yeah debts set in nominal terms uh it will sort of wither away gradually there was definitely a very strong very strong belief at that time particularly in the corporate sector that that belief hasn't returned the australian corporate sector has been pretty well disciplined since was that in a rational belief it's very hard to distinguish what's what's rational and irrational it certainly was wrong once everyone started doing it yeah it might have been rational if you were the only

one doing so there's a fallacy of composition. Yes, absolutely. Yes. Yeah. You once told me about a stud budgie bubble. Can you tell us that story? Well, during this asset price boom, we were looking at everything, not just share prices or property prices, although that's where the main action was, but it spread everywhere. Really? The paintings. The price of us, we followed the price of street and paintings yeah uh racehorses but the one that really struck me was that um the price of a stud budgerigar had quadrupled in a year i didn't even know what a stud budgerigar was this is like a male budgie used for breeding yeah yeah that's right yeah yeah that's what it is. Yeah.

And so there really was a very, very widespread asset price boom and a very strong belief that if you held assets, that's how you made money. How much did the price of stud budgies go up? They quadrupled. I don't know what the actual price was, but they quadrupled. Okay. So that was the real canary or budgie in the coal mine for you, I guess. Did this experience of the late 80s, early 90s, how did it prepare you for your role as governor?

Well, it was part of a general realisation that the role of the finance sector had changed. It had become much more important. When I started economics it was all about consumption and investment and employment and exports and imports you know real variables that's what you thought of all the time the national accounts gdp um but as my career progressed i started to realize that the purely monetary financial side of the economy was growing much faster and that was the potential source of problems. So instead of it being a shock absorber,

which it was really meant to be, it was actually becoming the source of the shocks rather than a shock absorber. And you can go through events like the third world debt crisis that was a financial crisis the american snl crisis was a financial crisis um the boom and bust that we're just describing at the end of the 80s early 90s that was really a financial crisis um even the the asian financial crisis was a financial. Too much money pouring into these small countries and then pouring out again.

The dot-com bubble was a financial crisis. Fortunately, it was one that did not involve very much debt. So that's why it remained... Well, it still produced a recession in the US and Europe. And, of course, the most recent one, the GFC. So it was quite clear that the risks had moved away from things that were predominantly in the real economy towards things that were predominantly in the financial sector. Right.

And that gradually happened over a period of my career, which is about 40 years. Right. And as you gradually came to this view that it was the financial sector, which was the source of instability, had you come to that view in part through immersing yourself in the classic literature, Kindleberger, Minsky, Walter Badgett, Irving Fisher, even back to Adam Smith talking about overtrading? Had you read all those guys?

I didn't find the economics literature very helpful at all in coming to my conclusions. I read Kindleberger. Minsky was regarded as a nutter. I hadn't read Minsky. I read Irving Fisher. I don't know how I stumbled on him. But no, I didn't get... the problem was the economics profession was actually wasn't helping me this was an era of uh

rational expectations and efficient markets when you turn to the the economics literature they were really telling you that these things couldn't happen, highly unlikely to happen. There was only a few mavericks on the fringe, the ones that you mentioned, that actually talked about these things. But I was really looking in the mainstream economic literature for help and not finding any. Right.

Now, rational expectations is the notion that we can collapse economists' models and the public's model of the economy into the same model. Now, you were never a rational expectations guy, were you? No, nor was I ever an efficient markets hypothesis guy. Were you a rational expectations guy at uni when you were reading from the textbooks? No, it didn't exist when I was at uni. It really came in, I think, in the late 70s,

mid-80s was really it's the high point. Right. When they were handing out all those Nobel Prizes to people who were writing a mathematical treatise involving rational expectations, as you reminded me, people suffering from physics envy. Yeah, we spoke about that last time. Yeah. Yeah. One of the things that always puzzled me

about rational expectations is just that if you observe that economists frequently change their own models, how can you expect the public to be stably and consistently behind economist models? That seems to be the biggest flaw in the theory. Yeah, very good point. Yeah. I want to digress briefly and talk about some central banking topics. And I apologize, this is going to be very, very basic to you, but I'm just thinking of educating as many people as possible, making sure everyone's on the same page. So, the Reserve Bank of Australia sets the official cash rate, but can you just explain to us how that at a mechanical level actually flows through to the economy how that influences interest rates because people need to remember there's a distinction

between the official cash rate there is a bank sets and then the interest rates in the economy and you know so the Reserve Bank meets on the first Tuesday of every month at 2 p.m.? No. 10 a.m.? 9. 9 a.m., sorry. I think it's 9. I can't remember. Maybe it's changed. I don't know.

And in that meeting, the Reserve Bank decides to change rates. From that point, what actually happens at a mechanical level? Well, interestingly, even before we adopted the practice of announcing what the official cash rate would be, we were still able to change the cash rate through our open market operations, which the Reserve Bank does every day. It's in the money market every day. If there's too much cash in the system, because perhaps there's been a big budget deficit that day, the Reserve Bank's in the market selling securities

to the banking sector and pulling cash out of the system. So it's in the market every day doing this, as all central banks are. But you don't read about it, but that's the core engine room of the central bank. If you want it, the only rate that you can really control directly is the overnight cash rate. The money, the amount the banks have to pay immediately if they want money.

And you can, even without the announcement effect, you can squeeze the system, which will push interest rates up, or you can flood the system a bit and it'll push interest rates down. So that's the starting point. We always had that capacity right um we at some point we decided that we should actually announce changes that made life easier because that told people don't even bother to fight just accept this is what it's going to be the american term don't fight the fed just accept that's what it's going to be but again you're only affecting the overnight cash rate, which is the amount the banks have to pay if they want cash. But that then feeds out across what's called the yield curve. The yield curve starts at overnight,

and in Australia, it goes all the way up to 10 years or past 10 years. And so there's a thing called the expectations explanation for the yield curve. If people think that the cash rate is going to go up, then all the way along the yield curve, interest rates will go up. If they think it's going to go down they'll go down so the the impact you have is really on the uh the overnight cash rate then the 30 day the 60 day the 90 the 180 day and it feeds out through the government bond market right out to in Australia principally to 10 years but much more muted as you go out along the yield curve. And that is, in some sense, that's the risk-free yield curve.

And it's really only the central bank and the banks that can effectively deal at that risk-free rate. Everything else has a risk premium on top of it. If you're a business and you want to borrow, you can't borrow at that rate. You've got to borrow at a higher rate. And if you're a BHP, it's maybe not much higher. If you're a speculative property developer, it's a lot higher.

So the Reserve Bank can principally affect the very short area from overnight to about six months or a year that's where its main effect is and the rest of it is based on people's guesses or assumptions about what's going to happen later on so that's why for example banks don't fund themselves entirely at the overnight cash rate so if the overnight cash rate goes up or down, that doesn't immediately translate into the bank's funding costs because they're also borrowing two years and five years, they're borrowing offshore. But certainly the central bank sets the short-term part of the

yield curve. Got it. As far as the borrowing offshore is concerned for Australian banks, people used to regard that as an Achilles heel in the Australian banking system. And indeed, towards the end of your tenure, a team of IMF economists in 2006 published a report where they identified that key weakness in the Australian banking system. That is the bank's over-reliance on offshore wholesale funding. Is that as much of a weakness as everyone thinks it is? No, and it never was. Yeah.

The problem was the way the statistician, the Australian statistician, published the data on banks' borrowing, that was counted. They borrowed in the US market, in US dollars, and that was published as though it was a US dollar borrowing with the US dollar currency roots attached to it. But what happened was the banks went into the international swap market

and they swapped it into Australian dollars. So banks had no foreign currency risk on their overseas borrowings. And so we actually at the Reserve Bank had to discuss this matter with the Bureau of Statistics and say, I think you'd better find a way of actually publishing another table which actually shows which parts of the overseas borrowing have foreign currency risk and which parts don't.

And they said, we can't afford to do that. So the Reserve Bank said, well, we'll pay for it. And so we then had a new statistical collection which demonstrated conclusively what we all knew was the case, that they weren't taking foreign currency risk. And no central banker would dream of taking currency risk in that situation. They hedged the hell out of it. Yeah, they was all hedged.

Entirely, 100% hedged. Yeah. Back to Central Banking 101 briefly. What are the three objectives of the Reserve Bank of Australia? Well, you've seen them on the chipped in stone and the foyer. Full employment, the stability of the currency, which is a very intriguing one. That could mean two or three different things.

And the welfare of the Australian population, which could mean a thousand things. Yeah. Now, the stability of the currency is commonly interpreted to mean inflation targeting. I think it is, but when it was written, it probably meant a fixed exchange rate. And when was it written? In 1949 or so. Yeah.

Yeah. Something very interesting occurred last year which is if you read some of the statements of the reserve bank of australia they seem to gradually cotton onto the fact that house prices can have a larger effect on consumption than they had realized thinking that their monetary policy statement of November 2019, they said words to that effect that the effect of house prices falls was more pervasive than we'd expected. Do you think like using the wealth effect, targeting the wealth effect as a policy, is that something you would have done in your day? Does that carry any risks?

Is it a desirable channel to influence the economy? I certainly don't think that it was part of the transmission mechanism that we relied on. I think there's a lot of soul-searching going on amongst central banks around the world, not just in Australia at the moment, about whether, with interest rates so incredibly low, and in some cases effectively zero, whether monetary policy is having any effect.

Now, I think, yes, it has. It's a full expansionary impact. But the question is whether any further changes would have much impact. At the margin, is there any room to do more? And there's a lot of soul-searching going on there. The sort of traditional central bankers like me think they've basically run out of room. There is really no value in going any further. But I think the current central bankers are sort of asking, well, what channels are there

left? If we lower interest rates, what channels will actually open up to help the economy? And the first one is they say, well, it means the exchange rate will be a little bit lower than it would otherwise be. That's true. Secondly, they say that for people who borrowers there's more disposable income if their interest bill goes down that's true but whether will they actually spend it we don't know or will they save it and the third one which surprised me a little bit was

to say if interest rates go down house prices will go up. Well, that's not a surprise. But then to say, and therefore that'll make people more comfortable and wealthier so they'll spend more money. Now, that's a channel I would never have liked to use. It seems to me to be, it may be true, but it's actually probably the least attractive channel for monetary policy to work through. Why? Well, because by putting interest rates down,

you're causing housing price booms. And if you say, oh, that's the only way we can get the economy to grow a little faster is cause a housing price boom, that's a massive price to pay. What's wrong with a good old-fashioned housing price boom? Well, I think you know the answer to that. Yeah. Your generation are the ones who are most acutely aware of it.

Yeah. Now, on that topic, you gave a speech in November 1995. This was about nine months before you would become governor of the bank. And you made some interesting remarks about housing. Your attention, I think, kind of gradually turned to the housing market more and more over the course of your governorship. But this speech back in 1995 was intriguing because you spoke about the significant intergenerational implications

of a housing boom. Just talk about the view you espoused in that speech back in 1995 and what are the significant intergenerational implications and why should we care about them? Well, I mean, I think there were people at that time who were saying this isn't much of an expansion because the house prices aren't going up. So this was the recovery out of the recession we had to have. And I was saying, well, why are you so keen on house prices going up? Because it might benefit you personally, but then if they go up too fast relative to incomes, it's going to make it very tough for the next generation who are trying to get into the housing market. In other words, I think I said very bluntly, you're making yourself

richer at the expense of your children. And I still think that is a big problem that has occurred in Australia. Now, a lot of it we couldn't do anything about. I mean, the fact that around the world, big cities that have got good job prospects, in each of those places people are competing to get in to buy property and house prices have going up very, have gone up very rapidly. New York, London, Singapore, Hong Kong, Vancouver, Toronto, Sydney, Melbourne, that's happening.

And secondly, during my period, there was an additional effect that was coming about because we finally got inflation down and were able to bring interest rates down. And when interest rates came down, people could afford to service bigger mortgages. So those were two things that we really couldn't do much about. But then on top of that, we had something which was really harmful, which was pure speculative activity, particularly through negatively geared acquisition of second, third, fourth, fifth properties. What period of time are you talking about?

I'm particularly talking about a period around the turn of the century from 2000, particularly 2002, 2003, when it was at its peak. Yeah. And it was starting to get pretty crazy then and it was starting to get very close to a bubble in fact i think i use the term bubble like activity i didn't say it's a bubble yeah um and at one stage uh i quote some figures where uh lending for investment purposes had risen by 40% in a year and lending for owner occupation by 1%.

Now, that to me is a very unhealthy housing market, which is totally dominated by speculation. I didn't like that at all. Does a bubble exist as long as prices are above intrinsic value? Even if they're falling but they're still above intrinsic value, would we still call that a bubble? I don't think I would. I think bubble, I would call a bubble a period,

well, A, of rapidly rising prices and where there's huge confidence that they will continue to rise. Right. I think that's the first phase of the bubble uh if they fall and they don't they don't fall back to where they started they remain a fair bit higher than they started i don't think you can call that a bubble interesting when we talk about intrinsic value it's it very difficult. Working out the market price of an asset is the easy part because it's just the price we observe. Working out the intrinsic value is difficult, maybe even impossible because when you capitalize the future cash flows into the asset price, you're using a discount rate.

But you can essentially justify almost any price level you're using a discount rate, but you can essentially justify almost any price level by tweaking the discount rate. How do you think about that problem? Seems to be a real epistemological challenge for talking about the existence of bubbles. Well, it's a challenge in this sense in that conventional accounting says that's what you should do if you want to work out the value of a non-marketable asset, something that's not trading regularly, is that you discount the future cash flows associated with it. And at the moment, and you use the risk-free rate to discount it. And at the moment, that is definitely pushing up recorded

asset values amongst all sorts of big funds. For example, superannuation funds, a lot of superannuation funds quite reasonably have chosen to invest in untraded assets. And so they face this issue of how do you value an untraded asset? And at the moment, I think the conventional accounting way of doing it is leading to very, very high asset values that may not prove to be sustainable. If one person wanted to get out, they might be, but if circumstances changed and a number one person wanted to get out, they might be, but if circumstances

changed and a number of funds wanted to get out, I think they'd discover that the asset values, that the proceeds of the SAR will be a lot less than their current market, their current conventional valuation. Yeah. One way to cut this knot of discount rates might be just to push all that to one side and just focus on beliefs of economic participants i'm not sure that i can answer that but like so for example case Case and Schiller, Chip Case and Bob Schiller, two American economists, began surveying homeowners in 1988 and then all the way through the US housing bubble of the 2000s. And they had evidence on what people thought the average annual increase of their home would be for the next 10 years. For example, homeowners, recent homebuyers in Los Angeles in 1988 towards the peak of the mini bubble in the late 80s and then again in say 2004 towards the peak of the mega bubble of the 2000s thought that their house prices would increase about 14% on average per

year for the next 10 years. And at the same time thought there was no risk in buying a home at that time. Most of them thought there was no, I think like two thirds thought there was no risk in buying a home at that time. So, you could look at over-optimistic extrapolative beliefs and then look at the changes in those beliefs using survey evidence. And, you know, ultimately all that matters is what people think is going to happen in the future. So you could almost sidestep the whole intrinsic value conversation. Well, you could certainly, I mean, on the evidence you just presented then, I mean, that to me is evidence of a bubble. Yeah.

Because it's absurd to think that other than in a period of hyperinflation, it's absurd to think that house prices could go up 14% per annum. Yeah. So that is definitely evidence of a bubble. But I don't know how you then get from that to saying, well, this is what the real price should be. I don't know how you then get from that to saying, well, this is what the real price should be. I don't know how you make the next step. Well, I think there's a sense in which real price is nonsensical.

Like, you don't even have to worry about that, but just the existence of a bubble, the fact that price is going to go up aggressively and then come down in a way that's damaging to the real economy is is is enough and then you just worry about that well it's certainly evidence i mean there's no doubt that's evidence of a bubble i mean i think a lot of people say the problem with thinking about bubbles is you can't identify them yeah and it is true that it's very difficult to identify them and until they've been running for quite a long time then you can start to identify them yeah it's true that it's difficult to

identify them but you're right that survey that sort of survey evidence would be very useful yeah you make a decision yeah there's not great long-term expectation survey data for australia we have the west pack and melbourne institute surveys but they only survey i think house price growth expectations for the next year um i'd love to get some long run stuff because there's you know the whole the whole point of chapter 12 of keynes's general theory was the state of long-term expectations. These vague ideas about the future play a role in forming bubbles. Let's jump back to the early 2000s while you're governor of the Reserve Bank. When things are heating up in the housing market, people forget how crazy it was.

And you'll remember this because you told me the house prices increased about 20% in one year. This was 2003. Now, the Reserve Bank of Australia was, I think, the first and only central bank in the OECD to raise interest rates at this time. Is that correct? Yes. In 2003, for example, the Fed was still putting rates down. Right. And we'd put them up twice in 2003. And we had actually already put them up twice in 2002. 2002. Yeah. So, publicly, you were a bit coy or you didn't want to, as you say, brand what was going on a bubble. And indeed, maybe it wasn't quite at that threshold yet. But privately, were you more concerned than you let on?

Oh, yes. Yeah. Right. I was concerned. In fact, some of my colleagues thought I was slightly obsessed. What did Glenn Stevens say to you? Some of your colleagues think you've become obsessed with house prices. And what did you say to Glenn? Some of your colleagues think you've become obsessed with house prices. And what did you say to Glenn? I don't remember what my answer was. I

probably denied it. But certainly, I mean... Were you obsessed? Well, I was probably more acutely aware of the dangers than my colleagues were. The issue is, though, that we had a monetary policy framework which we were very comfortable with, which was the inflation targeting framework. We'd only really bedded it down in 1996. You could hardly come out in 2003, seven years later, and say, oh, we've forgotten about that.

We're going to do something different. We'll just put up interest rates because we think house prices are going up too fast. So you couldn't say that? You couldn't do that. No. In fact, it wouldn't even really true. What was true, however, was that even though you have an inflation targeting framework, it doesn't mean that's the only thing we look at. You make an assessment and it certainly doesn't mean we don't do anything until inflation is already a problem. It certainly doesn't mean that. It means anything until inflation is already a problem it certainly doesn't mean that it means that sure that's the most important of the variables but we look at

how the overall economy is performing and some parts are always a bit weak some parts are strong some parts may be in a speculative boom and you sort of work out an average from that and ask yourself the question, should interest rates still be, at that time, at the low point that we put them down to? Should they stay at that low point or should we return them back towards normal? And so we believed that we should return them back towards normal because of our assessment of the overall development of the

economy with a sort of a medium-term perspective looking out further than your actual forecasts we believe that was the right thing to do and of course the fact that one part of the economy was really overheating did play a role in that and so it did play in a quite important role but it's not as though we ditched our inflation targeting regime and said, well, let's do something totally different. We didn't do that. And I think the public accepted it pretty well. The main argument was, look, the economy's returned to normal.

We don't have to have these interest rates at what were then thought to be emergency low levels. We ought to get them back to normal again. And that was a variation that was not pure inflation targeting rhetoric that was definitely a variation on inflation targeting rhetoric but the public accepted that now I had no idea about this until you told me but you actually sent junior economic staff to property spruikers seminars yeah I was delighted to hear this because, as you know,

I'm a frequent attendee of some of their seminars today. Tell me that story. Well, if you are interested in financial stability and potential sources of instability, not just inflation, and I was definitely interested in sources of instability. The big source of instability there was the housing market, speculative activity in the housing market. And the thing that was inflaming it was this industry of property spruikers who were convincing people that you should negatively gear and buy a second, a third and fourth property. I mean, this was the source of a lot of that speculative fervour.

And in order to find out what was going on, we sent people out. Younger members of the staff would go and attend these seminars and they'd come back and tell us some of the stories. Some of the stories we heard were really quite alarming, one of which was there was a new form of financial instrument had been invented called a deposit bond. So people would lend you money so you could put a deposit on an off-the-plan apartment development.

In other words, you didn't really have a deposit, you borrowed your deposit. And then when the thing was completed you have to borrow some more money to pay for it and we learned we learned about that we also learned that some of the um attraction or some of the the people they were trying to induce into buying properties were people so low on the income scale that when they did the arithmetic, they took into account the fact that by negatively gearing, you could lower your income to such a level that you would get more social welfare payments.

God. So we were learning. It was just a matter of learning. My feeling is if you're interested in financial stability, which central banks should be, and of course they all now are, it's no point relying on economic statistics or talking to the CEOs of banks.

You've got to be out there getting your hands dirty, talking to people at bars and talking to people at barbecues, going to suburban spruikers meetings. You have to do that sort of, it's almost like police work. Did you personally go to any of the spruikers no i didn't know no you probably went to barbecues and heard the irrational exuberance or everyone heard that yeah uh dinner parties people talk about property prices all the time at dinner parties yeah there was an article published in the australian on of the 4th to 5th of January 2020 about cash flow gains in the short to medium term. It is about capital growth, end quote.

You did some calculations a while back. Can you actually make that much money off capital appreciation investing in property? Well, I think the thing I wanted to investigate is do people actually make a lot of money out of negatively geared property? And my feeling is everyone thinks they do, but a lot of people don't. For example, a lot of people actually don't even succeed in selling it for more than they paid for it. I think there's some data on that that says if you sell it within five years, nearly 20%

of the people sell it for less than they paid for. But more importantly, I wanted to look into this idea of just because you sell it for a higher price than you bought it for, does that really mean you made any money? There's so many transaction costs. I know. The transaction costs of getting in, the transaction costs of getting out, and more importantly, all those years

of negative cash flow in between, if you do the calculation correctly and try and work out what the internal rate of return for the investment is, you have to have a whopper of a capital gain. In other words, you have to have a period where there's really been a sharp rise in house prices for you to make money. Most of the time, you don't make much money or you lose money. If you're lucky enough to buy right at the bottom and sell at the top, yes, you will make money.

But that's only a minority of people who do that. The majority, I think, either make not much more money than they would have in the bank, or in many cases they lose money. But there is this perception that it's so easy to make money, and this is what the property spruikers always capitalised on, this belief. I think one of the ones you mentioned to me was that there's a widespread belief that property prices double every 10 years.

Well, they don't. You can pick a 10-year period if you're careful where they have, but most of the years. Well, they don't. You can pick a 10-year period if you're careful where they have, but most of the 10-year periods, they don't. Yeah. But again, as with a lot of this quote-unquote financial advice, they are examples of what the psychologist Amos Tversky would call non-consequential reasoning, because if property actually doubled every 10 years and we extrapolated that out you'd get to a point where it just eats up the whole australian economy and you know it's just impossible yeah your counterintuitive decision to raise rates in 2002 2003 did that

ultimately take the wind out of the sails of this looming Australian housing bubble? Well, I don't know whether we did it, but certainly the house prices stopped rising. In 2004, they were flat. I think they might have even fallen slightly. I don't know whether we can take credit for that or not. But certainly that's what we were trying to achieve. And it was a sort of a gentle landing. They didn't collapse.

And because they didn't collapse, a lot of people say, well, it couldn't have been a bubble. It's only a bubble if it actually collapses. I don't know. I think the result was very satisfactory. I was very happy with the result. But whether we can take credit for it or whether it was just going to happen anyhow, I don't know. The economist Adam Posen says that central banks should not lean against the wind

because it's very difficult to identify ex ante whether a boom is going to turn into a bubble that wrecks havoc on the economy or whether it's just going to be a healthy benign boom. And if you raise rates, they're a very blunt instrument and you risk dampening other sectors of the economy for no good reason. What do you make of that argument? Well, I mean, there's definitely some truth in that, in that raising interest rates is a blunt instrument that affects a whole lot of people who are sort of innocent bystanders. So that aspect of it's true. I think what he's really describing is you shouldn't try and prick a bubble.

I don't like that term, but a lot of people see it that way. Oh, here's a bubble. Let's jack up interest rates and we'll prick it and it'll come falling down again like pricking a balloon. I don't think – I certainly don't see it that way. What I see is something much more akin to what you described as leaning against the wind, that the fact that one part of your economy is grossly overheated that affects the average too it's just

and that does influence your decision and number one your decision on interest rates and secondly there's a lot you can do that doesn't involve simply putting up interest rates i mean there's a lot to do with moral swage and public publicizing the, doing all that sort of stuff. And of course now there's also what we call macroprudential. You can do things to capital ratios. You can do various things about lending standards. And I think there's a range of things you can do that certainly don't fit into this idea of pricking the bubble. In 2006, you delivered the Boyer Lecture for that year. And the topic or the

title you picked was The Search for Stability. That's also the basis of a book under the same title. And in the book, you talk about a poignant fact of policymaking, which is that because people never have, they never see a true counterfactual, we can never fairly attribute credit or blame to policymakers for their decisions. And as I told you the last time we caught up, I consider you kind of like the silent hero of the Australian economy. I know you'd never say that about yourself, but I think it's true. Silent hero in the sense Nassim Taleb uses the phrase in his book, The Black Swan. And Kevin Rudd, the Prime Minister at the time, and Ken Henry, the Treasury Secretary at the time, are often held up as the heroes of the Australian economy who saved Australia from the global financial crisis and Great Recession with their decisive action at the time. You know, Henry's famous phrase, go hard, go early, go households. And Rudd unleashed a very aggressive stimulus package. But if it was not for the decisions you took to lean against the wind in the early 2000s their task i think would probably have been

orders of magnitude more difficult we were sort of the way house prices were increasing we were on a trajectory to head down the path of spain ireland and the us do you think there's truth to what i'm saying i think it's a bit um i think it's a bit too think it's a bit too flattering to all of us when you say I was silent I remember you saying that I was thinking about I think I was actually rather noisy but

I worked out that my period of government you were between the ages of 5 and 15 so you probably weren't reading the financial press or that to know that I was actually making a lot of noise. Actually, 4 and 14. Righto. Yeah. I was actually making a lot of noise and I was giving frequent speeches.

Silent in the sense that because we don't have the counterfactual, we'll never know and we'll never properly thank you for what you helped us avoid. Yeah, that's right. We'll never know and we'll never properly thank you for what you helped us avoid. Yeah, that's right. We'll never know. You're right. I mean, we will never know whether it would have run out of control and led to a bust. We don't know. And so there's really not much point speculating on it.

But the issue of not being able to observe the counterfactual is very important, and I spent a bit of time in that final chapter of the Boyle Lectures explaining that. And, of course, you quote the even better example, the example from the Black Swan, where if there was some senator in America who had insisted on passing a regulation forcing all airlines to lock the cabin door between the pilots and the passengers um to be introduced to be introduced on the 10th of September that would have prevented uh the you know the disaster 9-11 disaster it would have

prevented it but would he have ever got any credit? Because he probably would have been regarded as some sort of overzealous regulator who was putting in all this red tape, forcing companies to do things that were totally unnecessary. There's an interesting line, though, in the prologue of the book after he gives that analogy. He says, he gives a few other examples,

and he says, who will be more thanked, the central banker who helps his country avoid a recession or the central banker who's around for the recovery or there to give the direct action response? You finished up as governor in 2006. You got out just in time. Did you see the global financial crisis coming? No, in the sense I think the only people who could claim to say they saw it coming. I certainly said the next crisis will be from the financial side. That's where the big risks are. I've said that on numerous occasions.

But that doesn't qualify me for saying that I predicted it. I think to make the claim that you predicted it, you would have to, A, have nominated when it was going to happen. It started in the middle of 2007 and reached its full intensity in 2008. And secondly, you would have to have identified the epicentre of it with the structured products made from US subprime mortgage loans. You'd have to get both of those things right to be able to claim that you had foreseen it. And I don't know anyone who did.

I know you claim, and you may be right, that there was a hedge fund manager in the US. Michael Burry. Yeah, who did. But I would say he's probably got the only one then, because he actually made money out of it, he may be the only one who has he actually made money out of it he uh he's maybe the only one who couldn't who has a valid claim to saying they foresaw it you can also read his reasoning as well i sent you his vanderbilt university speech from 2011 and you can read his letters to investors at um investors in scion capital his hedge fund. He was pretty close to, but again, you know, we always have to grapple

with this problem of survivorship bias. Like, you know, that old idea that the definition of infinity is if you have a group of monkeys in a room bashing on typewriters, at some point, one of them's going to punch out hamlet somewhere in the world someone is going to be predicting something at any point in time and the fact that michael burry got it right is that because he quote unquote predicted what would happen or was he just super super lucky very hard to answer that question i know well it's also there are a lot of people who constantly predict a recession yeah uh all through my governorship there were people very hard to answer that question i know well it's also there are a lot of people who constantly predict a recession yeah uh all through my governorship there were people predicting a

recession and all through the period since i left there've been people predicting a recession for australia and um at some point there will be but and they'll say oh i told you so i was right well no you weren't you've been predicting it for 20 years, and it only happened one year in 20, so you've got a success rate of 5%. If I had followed your advice, I would have lost a lot of money. Hmm. So Australia avoided the Great Recession.

We now have this unprecedented economic expansion, now heading into its, what is it, 28th year. And we had another big run-up in house prices between 2012 and mid-2017. Did that second run-up seem bubbly to you in the way the first one was back in the 2000s? Yes, yes, but not quite as much, but definitely did seem bubble-like. Not as zany as the first one? No, it wasn't so exclusively dominated by speculative investment purchases. Although it still was.

Yeah, but not exclusively. It was still dominated by it, but the 2003 one was almost exclusively investment-led. Right. Yeah, no, it was quite disturbing. I was very unhappy about it. And, of course, you could feel the sort of annoyance and anger of the younger generation who were sort of hoping it would stop. In fact, a lot of them were incorrectly predicting

that it was bound to stop because it was definitely a bubble and it would fall over. But it was a correction. The correction seems to have evaporated over the last six months. Is that a good thing in the long term? No, it probably would have been better to have had a bigger correction. Right. Although in the short run that would have hurt a bit.

Probably a lot. The economy is chugging along, but pretty lacklustre growth. If you had a bigger housing correction, I think it probably would have meant a much weaker economy. But in the very long run, it would probably have been beneficial. Right. There was a story I forgot to ask you when we were talking about the global financial crisis a moment ago.

When you were talking with your American colleagues, they were talking about variable rate loans. Can you tell us that story? Yes. There was a meeting, a regular six-monthly meeting, called the Financial Stability Forum. What year was this? Oh, this was 2005, 2006, I'm talking about,

which is one of the forums that Australia was invited to join. It was a G7 plus four countries, and we were one of the four who joined it. And we used to discuss risks to the world economy and financial stability, what have you. And the Americans, a couple of times, the American representatives would say, oh, yes, we're a little bit worried about variable rate mortgages.

And the Australians and the English and a few others looked at each other, well, what's wrong with variable rate mortgages and the Australians and the English and a few others looked at each other well what's wrong with variable rate mortgages we've got variable rate mortgages with Australian mortgages go up and down with the either the cash rate or the least the 90-day bill right it's not 84% of our mortgages are variable yeah yeah so what's wrong with that but what we didn't realize is they variable rate mortgages, they meant something completely different to what we had always used.

They meant mortgages where you borrow at 2% and after two years, the interest rate goes up to 6.5%. We had no idea that that's what they were talking about. If we had known that, we would have been alarmed and we would have questioned them seriously about what's going on and what are you doing about it? Why are you allowing this instrument to even exist?

But we just thought variable rate mortgages were the same as Australian variable rate mortgages. You could have saved them. I don't know whether we would have saved the world, but I think we would have put them on the spot and made them do a lot of more thought about it and yeah question them and and probably uh criticize them severely for allowing such a dangerous instrument to be readily available so as we sit here today house prices in sydney and melbourne are recovering

rebounding quite strongly the australian economy is sluggish So, as we sit here today, house prices in Sydney and Melbourne are recovering, rebounding quite strongly. The Australian economy is sluggish. Australia has the second highest household debt to GDP ratio in the world. There's still this meme that our economy is focused on houses and holes. What is your outlook for Australia in the next three to five years, to pick some arbitrary numbers, and what should we be doing to ensure the same level of prosperity going forward as we've enjoyed in the last two decades? I'm reluctant to answer that.

It's just such a broad question. It is. I'm sorry. I think I prefer not to. Sure, sure. Particularly as someone who's become less and less confident in our ability to forecast. Yeah. That's the other thing that over my career, first of all, I've shifted my perception of where the risks come from, away from the real economy towards the financial sector. The other thing I think I've learnt over that period

is our ability to forecast is much, much lower than we thought it was. We spent a fortune building economic models, but didn't achieve anything. And as a result, what we now tend to think is instead of trying to forecast what's going to happen and offset it now, it's much better to admit that you can't forecast, but try and make sure that your system is resilient, that it can bend rather than break, which is a very different mindset to the mindset we had when I first entered the economics profession.

Yeah, which is essentially to build an anti-fragile system. Yes, yes. Let me ask a slightly more specific question. Do you still see risks in our housing market? Do I see the risk of a collapse in house prices i don't i'm i don't i um i think that those huge long-term structural factors are so powerful the desire for people to to compete with each other to buy houses or apartments in places where there are good jobs which means big cities people coming from other parts of the world to do it people come from the country to do it, people come from the country to do it, people are already here doing it. I think there is a fundamental shift in the relative price of housing has occurred over

the last 30, 40 years. I don't think it's ever going to go back to where it was. On the other hand, I don't think it can continue to go up as fast as it has over that period. I think we've reached the limit of the household sector's capacity to service mortgages. I don't think you can relax that in any way for any further. So I think the underlying growth of house prices will be a lot lower than they have been over that period, but I don't foresee a collapse in house prices bringing them back to some former,

more affordable situation. One of your predecessors once told you a story of learning to drive in 1939 in the outer suburbs of Melbourne, where you grew up back in the 1950s. And it has links to the famous Melbourne land bubble of the 1880s. Who was the predecessor, and what was that story? Well, Bob Johnson, who was an early governor, who was brought up in Melbourne, as most of the governors were. It's just a better city. I don't know.

Anyhow, Bob Johnson, Harry Knight and myself all came from Melbourne. Now, he was saying that the land boom of the 1890s in Melbourne was so huge that there were developments, whole suburbs developed with roads and footpaths waiting to pour more houses into and then the bubble burst and so the houses never got built but there were suburbs without houses that road but no houses existing around melbourne streets and so all the young people of melbourne when they learned to drive used to go there and drive around these empty streets wow because no when

that's 30 years later nearly 40 years later and they still hadn't. And that's 30 years later, nearly 40 years later, and they still hadn't been developed. That's amazing, isn't it? Yeah. Because when you were growing up in the outer suburbs of Melbourne in the 1850s, 1950s, sorry, Freudian slip, no one really spoke about the Melbourne land bubble. It had kind of been forgotten by the public, hadn't it?

Yeah. Yeah. It had been forgotten. There was a very good book on it, Michael Cannon's book, The Land Boomers. I'm not sure when that was published. I think it might have been published in about 1980 or something. Land Boomers?

Yeah. In the 1960s. Was it? Yeah. Well, they were quite a scandalous book because it threw some shade on many of the very elite Melbourne families. Yes, that's right. And their misdeeds during the land bubble.

Yeah. There was another book, I think it, yeah, another book called Marvelous Melbourne by an economic historian, which is slightly less sensational than The Land Boomers. I've only read The Land Boomers though. I'm trying to get my hands on the other one. While we're talking about Melbourne during the 1880s, let's return to your book finally.

By 1885, Australia was the richest country in the world. We had the sheep's back and we also had a bounty of mineral wealth. I think something like one in 50 people from the British Isles had moved down under to pursue a new life. And it must have been a really exciting time. The population was between three and four million, mostly concentrated in the urban centres. And what strikes me is all of the subjects of your book, Ten Remarkable Australians, were born during that period in the late 19th century. And I wonder whether you gathered from researching them, whether they had an intrinsic sense of being Australian and what it meant to be an Australian back then, because this was obviously pre-Federation.

Australia was still just a set of English colonies. It's a good question. And the answer is that, yes, they did feel Australian, which is, as you say, perhaps surprising because most of them left Australia before Federation. They were all born before Federation and most of them had already left Australia. So when they went out the world to make their name, they didn't see themselves as a Victorian or a New South Welshman. They saw themselves as, or nor did they see themselves as Englishmen.

They saw themselves as Australian. Interesting. Which is interesting. A couple of them, it's very surprising. For example, Finch, the mountaineer, never returned to Australia. And you'd think, and he lived the rest of his life in England, and you'd think that he would

conceive himself as being an Englishman, but no, he still referred to himself as an Australian. When he wrote his book, he wrote a marvellous book called The Making of a Mountaineer, and the introduction, he talks about his experience, his first experience of climbing a mountain. It couldn't have been much of a mountain,

probably not much more of a hill, because he climbed it near Orange in New South Wales. So he still saw himself as Australian. Even Gilbert Murray, who left Australia very young, completed his secondary education in England, became Professor of Greek at Oxford University, and a very important public intellectual, probably the most important public intellectual in England in the 1920s.

Wow. He only came back to Australia once, briefly, but he, for example, he was always broadcasting on the BBC when it was the Monopoly broadcast in England, and on four of those he devoted his half-hour speech to aspects of Australia. He became the president of the Australian Writers in England. And he wrote his autobiography. He didn't finish. It was called Unfinished Autobiography. It was only about 88 pages,

of which 48 were about his early years in Australia. He was always seen as an Australian. He was always proud to be seen as an Australian. So all of them definitely accepted they were Australian, not English, and nor did they identify with the particular colony they came from. They all identified as being Australian. I don't think I covered that as well in the book as I should have,

but a number of people have asked that question, as you asked it. It's a good question. And it is surprising, really, that so early in the piece, these people from these separate colonies, when they're overseas, did definitely think of themselves as Australian. Reading about their lives does make me proud to be an Australian.

And they all were inspiring individuals in their own ways. Ian, it's been a privilege speaking with you. Thank you for writing this book, 10 Remarkable Australians. Thank you for allowing me to discuss it with you and to discuss an 11th Remarkable Australian and quiz you about economics and your career. Thank you, sir. Well, thank you very much, Joe. I thought your questions were very incisive. Thanks so much for listening. I hope you enjoyed that conversation as much as I did. For show notes and links to everything we discussed,

you can find those on my website, www.josephnoelwalker.com. That's my full name, J-O-S-E-P-H-N-O-E-l-w-a-l-k-e-r.com you can also find me on twitter my handle is at joseph n walker and before you go two quick favors if you are enjoying what i'm doing then please leave a rating and a review on itunes i know everybody asks but it does help and i do appreciate it and finally if you think ian mcane, our guest, is as much of a legend as I think he is, there is a way you can show your appreciation to this silent hero of the Australian economy. I encourage you to buy his book, Ten Remarkable Australians. It is immensely enjoyable and insightful.

You can find it on Amazon or Booktopia or wherever you buy your books, but I'll also leave some links up on my website. Until next time, thank you for listening. Ciao.