be some movement of inflation over the course of the cycle, but we want to make sure that inflation does not rise over time ( now that price stability has been achieved ). you can see this sense of priorities - - with medium - term price stability being the sine qua non, and our acceptance that inflation may vary a little over the course of the cycle - - in the specification of the inflation target as being an average “ over the course of the cycle ”. this has caused quite a bit of misinterpretation about the specification. in talking to an audience such as this, i can take the time to set out quite specifically what we have in mind by “ over the course of the cycle ”. we can go back a bit in history to illustrate the point here. in the 1950s and 1960s ( see graph 5 ), inflation moved about quite a bit - - from more or less zero to around 5 per cent per annum - - but people look back on this period as “ price stability ”. why is that so? the critical issue here is that even though inflation rose and fell over the course of the cycle, price expectations did not move - - even when inflation was running at 5 per cent, the community at large expected it would soon be back to its normal lower pace. stabilising and maintaining price expectations is the key issue in thinking about the question of “ over the course of the cycle ”. the - 11 - graph 5 : bank should not be so trigger happy that it tightens policy at every threat of a price rise ( no matter how slight or temporary ). there is a trade - off between output stabilisation and price stabilisation ( see debelle and stevens ( 1995 ) ), and an attempt to smooth the path of prices perfectly would make policy destabilising. we want to be on - - and stay on - - the short - term phillips curve associated with 2 - 3 per cent price expectations. we would not be too fretted if actual inflation moves about a bit over the short term, provided price expectations do not change ( i. e. we stay on this short - run curve ). to put this in operational terms, if we have limited price stability credibility, we have to be more careful that inflation does not depart much from 2½ per cent, or depart for too long. as credibility builds over time, monetary policy does not have to respond to every hint of inflation, knowing that the small fluctuations

3 per cent. 7 / 13 bis central bankers'speeches 8 / 13 bis central bankers'speeches the low cpi and wage outcomes in australia have seen some decline in inflation expectations, although not to the levels seen in many other countries. consumer inflation expectations are lower than they were some years back, but are not at unprecedented levels ( graph 8 ). marketbased measures of long - term inflation expectations have also declined, but they remain consistent with the inflation target. 9 / 13 bis central bankers'speeches looking to the future, we expect that the various factors holding inflation down will continue for a while yet. but this does not mean that we have drifted into a world of permanently lower inflation in australia. domestic demand is expected to strengthen gradually as the drag on our economy from the decline in mining investment comes to an end. as this happens, the excess capacity, including in the labour market, is likely to be wound back. some pick - up in wages and prices could then be expected. in addition, commodity prices, after having declined over the preceding four years, have increased this year. if sustained, this will boost national income and falls in petrol prices will no longer be having a significant effect on headline inflation. in terms of the downward pressure on prices and wages from increased competition, this is likely to continue for a while yet, but it is probable that this pressure will lessen at some point as domestic demand strengthens. putting all this together, our central forecast remains that inflation in australia will gradually pick up over the next couple of years, although it is still likely to be closer to 2 per cent than 3 per cent by the end of this period. flexible inflation targeting i would now like to turn to the monetary policy framework as this provides the structure within which the reserve bank board makes its decisions. the centrepiece of this framework is a 10 / 13 bis central bankers'speeches flexible medium - term inflation target, with the objective of delivering an average rate of inflation over time of between 2 and 3 per cent. by achieving this we can provide a strong medium - term anchor for people ’ s inflation expectations and reduce one element of uncertainty in the economy. this is an important precondition to sustainable growth in employment and incomes. most people can cope without too much difficulty with a bit of variation in inflation from year to year, but it is the medium - term uncertainty that is really damaging to planning. i hope that it is well understood that our framework allows for temporary deviations of