declining debt levels. prudent fiscal management should have recommended that the boom in private spending be partly offset, even if only by letting automatic stabilisers play their role. however, while private sector dynamics were very similar within the group of converging countries, the behavior of the public sector was markedly different. as this “ new world ” of low interest rates and abundant financing seemed to offer a free lunch to the converging countries, several imbalances started to build - up. such imbalances took different shapes : in countries such as portugal or greece, fiscal imbalances became a major problem – even if the size of the problem was, and actually is, substantially different. in both countries, savings arising from lower interest rates and boom - related windfall bis central bankers ’ speeches revenues were used to finance expansionary expenditure policies. when interest rate convergence was completed and the initial impact of emu on growth disappeared, the underlying unsustainable fiscal policies soon became apparent. also, structural bottlenecks arising from lack of competition and an excessive weight of the public sector in the economy, contributed to an overexpansion of the nontradables sector, hampering competitiveness and aggravating external imbalances. in countries such as spain or ireland, fiscal policies were more prudent. still, imbalances built - up, mainly taking the form of a real estate bubble. in ireland, an oversized financial sector developed in tandem with the real estate bubble ( a similar phenomenon also occurred in non - euro area countries, the most prominent case being iceland ). as the financial crisis emerged in mid - 2007, and then developed into global recession, the response of policy authorities around the world was the massive provision of liquidity by central banks coupled with huge fiscal expansion and the assumption or guarantee of banks ’ debts by governments. the aim was to mitigate the impact of the crisis on output and employment and to prevent a fully - fledged crisis that could resemble that of 1929. the consequence was of course a strong deterioration in the balance sheet of the public sector in general. the resulting sustainability concerns, especially for those countries where the room for maneuver was more limited, have brought us to the third stage of the crisis, where we now are – the sovereign debt crisis, which has so far mainly affected the euro area peripheral economies. 2. how to explain what has happened? with the benefit of hindsight, how can we explain the developments of the past

hence to set the short - term price of money, based on domestic considerations. this is the hallmark of a modern monetary policy. the extent of short - term variability in interest rates declined while, naturally, that of the exchange rate rose somewhat ( graph 3 ). a flexible exchange rate is also a critical component of inflation targeting, which is australia ’ s monetary policy framework of choice. admittedly, for some years exchange rate considerations were still sometimes seen as something of a constraint in the conduct of monetary policy. this has been progressively less the case, though, as the credibility of the inflation target has increased. even if all the flexible exchange rate did was to allow monetary policy to operate effectively, that was a major benefit. but the float did more than just that. real exchange rates move in response to various forces affecting an open economy, even if the nominal exchange rate is fixed. given the slow - moving nature of the bulk of prices, allowing the nominal exchange rate to change makes the process more efficient unless there is excessive short - run variability in we found ourselves “ out of favour ” despite the fact that it was almost certainly the use of information technology rather than its production that made for the biggest gains to a society and on that score australia ranked highly. the price put on our currency by the market seemed at odds with other things and that episode saw the first use of results from a model in a speech by a reserve bank governor to demonstrate that point ( see macfarlane 2000 ). bis central bankers ’ speeches the nominal rate. as hedging markets develop the cost of short - run noise is usually lessened. in my view the flexible exchange rate has helped adjustment in the real economy in its own right. the combination of allowing monetary policy to operate effectively and fostering real economic adjustment is very important. one very telling comparison is between the macroeconomic performance in the most recent commodity price upswing and that in the episodes in the early 1950s and mid 1970s ( graph 4 ). it is obvious that there has been a first - order reduction in macroeconomic variability on this occasion. the flexibility of the exchange rate has been a major contributor to that outcome. 5. has the exchange rate been “ misaligned ”? the currency has certainly moved through a very wide range over the thirty years since the float. if our metric were some constant target level of “ competitiveness ” measured, say, by relative unit costs, then we would be drawn to the conclusion that it has been “ mis