mr. macfarlane speaks to banking supervisors on the challenges for the world ’ s economic policymakers talk by the governor of the reserve bank of australia, mr. i. j. macfarlane, on the occasion of the 10th international conference of banking supervisors held in sydney on 21 / 10 / 98. i would like to start by adding my voice to those who have already welcomed you to this conference and to the city of sydney. it goes without saying that there could hardly be a more propitious time for the international leaders in the field of bank supervision to be meeting. when we first started planning this conference a couple of years ago, we did not know whether it would attract a lot of interest or would be greeted with a yawn. we now know it is the former, and we in the reserve bank, and our colleagues at the australian prudential regulation authority, with whom we are jointly hosting the conference, are sure that you will be in for a very interesting couple of days. it is hard to pick up a newspaper these days without seeing the word “ crisis ” prominently displayed in a headline somewhere. first, we had the asian crisis, then it spread into being an emerging markets crisis, and now we hear so much talk of a world financial crisis. it is interesting that, so far, the focus is on the word “ financial ” and not on the more general word “ economic ”. it is also interesting that these troubling financial events are no longer confined to emerging market economies. one consequence of these two trends is that the contrast between economic health and concerns about the financial sector is as marked in the world ’ s most powerful economy - the united states - as elsewhere. there is a big challenge, therefore, to the bank supervisors of the world, and it seems to be equally large whether they are dealing with the least, or the most, sophisticated of the world ’ s banking systems. i see two main challenges for the world ’ s economic policymakers - one for the short term and one for the medium term. in the short run, the challenge is to get through the current crisis - to make sure no more dominoes fall through contagion. the region at risk is clearly latin america, even though many of these countries are now running infinitely better macroeconomic policies than could have been imagined a decade ago. it would be tragic for them to be blown off course by the spread of financial turbulence that they had no significant part in the making of. it

people to borrow more and spend. lower interest rates also reduce the servicing burden on existing debt, which can free up some cash to spend more. overall, though, we would ordinarily expect debt to rise when monetary policy is boosting growth. when household debt is high, it poses some risks. in particular, it could make household spending and well - being less resilient to shocks, including individual - specific outcomes. so the question then arises : what is the appropriate balance between the risk of higher debt and the benefits of the hoped - for faster decline in unemployment? in part, this depends on whether a particular level of interest rates induces households to keep increasing debt indefinitely, or whether debt instead accumulates up to some point, or some relativity to income, and no further. the experience of recent decades, and the arithmetic of debt - servicing burdens, suggests the latter. 2 but it is hard to be certain. another question to ask when weighing up this balance is whether the question of how low unemployment can go depends on how fast you are getting there. it ’ s usually assumed that there is a level of unemployment, below which wages growth starts to pick up. this is sometimes called the ‘ full employment ’ rate of unemployment. a more technically correct, but less attractive, name is the ‘ nonaccelerating inflation rate of unemployment ’, or nairu. 3 in some other countries, unemployment has fallen well below previous estimates of the nairu before wages growth actually started to pick up. as a result, more recent nairu estimates have tended to be revised down. that brings me to two examples of a learning lag that i consider to be particularly relevant to the current situation. the first is the simple one that it might just take a while before firms start to realise how hard it is to find suitable labour, and decide to offer higher wages. so it could be that it takes a little while for wages to pick up once unemployment has fallen below the nairu. if so, it would mean that nairu hasn ’ t really moved in these countries, and the revisions we see are just an artefact of the way this unobservable variable is measured. if that is what is going on, then this mechanism would also be relevant in australia. as the bank has explained on several occasions recently, although there appears to still be a deal of spare capacity in the labour market, many firms are reporting that they are finding it hard to recruit suit