restraint on demand. on the other hand, this carries the risk that a long period of high inflation could lead to expectations of inflation rising to the point where it becomes both more difficult and more costly to reduce it. monetary policy has to balance these risks, which is why the flexible, medium - term inflation targeting system that we have been operating for 15 years now, and which has enjoyed strong bipartisan support in the parliament, is so important. that framework will continue to guide the board ’ s decision making. my colleagues and i are here to respond to your questions.

a scenario involves making alternative assumptions to the ones in our baseline forecast about how things we are uncertain about play out, and thinking through what that implies for the economic outlook. we often use economic models to explore how these alternative assumptions affect economic outcomes. part of the value of producing scenarios is that they help us build our own understanding of which risks are important, because the scenario makes clear how sensitive the outlook is to a given risk. that can help us decide which issues we need to dig into more to understand better. scenarios also provide a way for us to communicate the risks that we think are most important, and a tangible way of illustrating and quantifying them. by tracing through the impact of a risk onto both inflation and unemployment, they help us to understand how risks around those variables are connected in a way that fan charts cannot. for us as forecasters, there is a further possible philosophical benefit to producing scenarios : i wonder if it might reduce the chance that we become too attached to our central forecast narrative. constructing scenarios means thinking through alternative narratives, and that should help us keep an open mind when our central forecast turns out to be wrong. and as i said earlier, it almost certainly will be wrong in some way. more concretely, scenarios can help us identify the indicators and outcomes that will tell us when we are deviating from our baseline view. this helps us to identify when things are playing out differently, allowing us to update our baseline forecast accordingly. i ’ ll return in a minute to talk about the value of scenarios in informing the policy decision. but let me first give two recent examples of scenarios we have used. household income growth and consumption a key uncertainty we ’ ve been considering recently is how household income growth will affect consumption in the coming years. household real income is currently being lifted by the stage three tax cuts taking effect. but we cannot be certain how consumers will react to this lift in income. running different scenarios allows us to see how the different responses might play out and how material this would be for the labour market and inflation. the alternative plausible paths for consumption ( graph 2 ) and the savings rate led to noticeably different paths for inflation and unemployment that would have consequences for policy setting ( graph 3 ). 3 graph 2 r e s e r v e b a n k o f au s t r a l i a graph 3 we first published these scenarios in our august smp. 4 as the charts show, the different cases have material implications for inflation and