i j macfarlane : overview of the australian economy opening statement by mr i j macfarlane, governor of the reserve bank of australia, to house of representatives standing committee on economics, finance and public administration, warrnambool, 6 december 2002. * * * i would like to endorse the remarks of the chairman and say what a pleasure it is to be in warrnambool, for the second hearing to be conducted outside the sydney - melbourne - canberra triangle. the first was in wagga wagga, and i remember at the time suggesting that the second should be a little further away from canberra. warrnambool passes that test and is an important agricultural and tourist centre, so it is a fitting venue for this meeting. i would also like to thank the mayor of warrnambool, councillor james nicol, for his hospitality in hosting a civic reception for the committee and the members of the bank appearing before it. i would like to start the substance of this statement by observing that in the six months between this hearing and the previous one in may quite a lot has changed, and this has had an important influence on our judgment about what we have needed to do with monetary policy. this change has happened relatively steadily, with the result that the financial markets and the public more generally have had no trouble in adjusting to the changed outlook. we have assisted, where we thought necessary, by way of several speeches and articles on the subject over the past six months ; they have probably helped at the margin, although i think the public was not having any difficulty in recognising the changing outlook as it unfolded. that being so, it could be argued that there is nothing further to add on the subject. however, i am very aware of the fact that i gave some quite frank indications about the expected future direction of monetary policy at the previous hearing, and that those indications have not been followed through. so i would like to place on the record before this committee another account of the changing circumstances, even at the risk of being accused of going over old ground. in may i said to this committee that since the australian economy was behaving normally, and the world economy was getting back to normal, unless unforeseen developments intruded, we should continue the process of getting real interest rates back to normal, while all the time carefully examining incoming data, both from here and abroad, to ensure that developments remained on track. we did continue the process of getting

than stronger. having said that, i recognise that even though the second half of the year has been disappointing compared with the first half, equity and bond markets have become a little more confident over the past month or so. it is too soon, of course, to know whether it represents a change in direction or just another blip in the data. turning to the australian economy, i will approach this by way of my usual practice of reviewing the forecasts i gave the committee last time and presenting some new ones. last time i said we expected gdp growth through 2002 / 03 to be between 3½ and 4 per cent - we are now forecasting around 3 per cent. obviously, the major factor behind the reduction has been the drought, but the weaker world economy has also had an effect at the margin. on the other hand, the fact that house - building is now forecast to continue to expand for a longer period has pushed the forecast up somewhat. for next year, that is calendar 2003, our forecast is for growth through the year of 3¾ per cent. the fact that it is higher than the current financial year rests importantly on the assumption that there is a recovery from the drought in the second half of the year, and that the world economic recovery gradually picks up momentum through the year. as i said before, strength in house - building has continued for longer than earlier thought : nevertheless, we still expect a downturn to occur in that sector during the course of 2003, which will subtract from growth. on the inflation front, i said that we were forecasting the cpi to remain near the top of the target range in 2002 / 03, although we expected it to go down slightly for a time and to then come back up. implicit in this forecast was that the rising phase would continue after mid - 2003 and so, other things equal, begin to exceed the target range by the second half of 2003. what has happened so far is that headline cpi is slightly above 3 per cent, but our estimate of underlying inflation is that it is running at about 2¾ per cent. we see no reason now to expect underlying inflation to rise any further, and are now forecasting that it will stay around this rate through calendar 2003. the main reasons for this slight downward revision compared with our forecast six months ago are the lower forecasts for world and australian growth. the price effects resulting from the drought will have the effect of holding up cpi inflation in the next quarter or two and then