i j macfarlane : what is the biggest risk to financial and economic stability? introduction by mr i j macfarlane, governor of the reserve bank of australia, to the panel discussion on financial stability - consilium, coolum, 9 august 2003. * * * from the perspective of a developed oecd ( organisation for economic co - operation and development ) economy, what is the biggest risk to financial and economic stability? i suspect that at various stages over the past few decades, we would have come up with different answers. for much of the period, we would point to our apparent inability to control inflation, or to oil price shocks, or to governments ’ inability to control their finances. at other times, people would point to more purely financial vulnerabilities, such as fragile under - capitalised banking systems, excessive short - term international capital movements, poor prudential regulation or inadequate systems of governance. others would point to the tendency of governments, central banks or the imf ( international monetary fund ) to bail out failed systems and so create a moral hazard, as the main risk to future stability. you can make a good case for most of the candidates i have put forward. however, i think there is one other risk that we have become aware of that now seems to be larger than those i have listed above. i refer to asset price booms and busts. while the existence of these was recognised, they were usually regarded as historical curiosities, or at least very low frequency events ( e. g. once or twice a century ). the us experience in 1929 and its aftermath was the classic case until recently. but now that we have seen the world ’ s second largest economy - japan experience one in the 1980s, and the world ’ s largest one - the united states - experience one in the 1990s, they seem to be not quite so ‘ low frequency ’. we should also not forget that many other economies, including our own, experienced an asset price boom and bust in the late 1980s and early 1990s. although they were not of the size of the japanese one, or of the international significance of the us one, they were very costly to their respective economies. what can be done about this tendency of otherwise well - managed economies to exhibit periodical asset price booms and busts? one response would be to give the task to monetary policy, so you will probably expect me to expound on this subject. unfortunately, i must disappoint

too much longer, the effects on economic growth are likely to be significant. for this reason, the risks to the global economy remain tilted to the downside. the combination of these persistent downside risks and continuing low rates of inflation has led investors around the world to expect interest rate reductions by all the world ’ s major central banks. in europe and japan, official interest rates are already negative but investors are expecting the central banks to go further into negative territory. and in the united states, investors are expecting a substantial reduction in interest rates over the period ahead. this is quite a different world from the one we were facing earlier in the year. what all this means for us here in australia is yet to be determined. we need to remember that the central scenario for both the global and australian economies is still for reasonable growth, low unemployment and low and stable inflation. as i discussed a few moments ago, there are a number of developments that are providing support to the australian economy. so we will be closely monitoring how things evolve over coming months. given the circumstances, the board is prepared to adjust interest rates again if needed to get us closer to full employment and achieve the inflation target in a way that supports the collective welfare of all australians, including those who call the northern territory home. thank you once again for joining us this evening and for listening. related information minutes of the june 1968 reserve bank board meeting historical photographs of the reserve bank ’ s presence in darwin 4 / 4 bis central bankers'speeches