seeking in australia in recent years. that this is necessary is confirmed by the fact that inflation has picked up somewhat. cpi inflation in 2003 was 2. 4 per cent. in 2004 it was 2. 6 per cent, and in 2005 2. 8 per cent. in mid 2006 it was nearly 4 per cent. to be sure, the consumer price index was affected by the rise in oil prices, and most spectacularly, the effects of cyclone larry on the queensland banana crop during march of last year. but the rise in prices was more widespread than just those items. measures of underlying inflation, less influenced by specific price shocks, suggested a pick - up, albeit a much more modest one, from about 2½ per cent to about 3 per cent by mid 2006. a short - lived pick - up of that magnitude is not necessarily a major problem in itself. but in an economy with limited spare capacity, continuing signs of quite solid growth in demand, and experiencing a substantial external stimulus, that gradual trend rise in underlying inflation was worrisome. a continuation of this trend could have seen inflation exceeding the 2 – 3 per cent target over a more sustained period, even after temporary factors had disappeared. it was this risk – not banana prices or petrol prices per se – to which monetary policy had to respond. it was intended that the rise in interest rates, by restraining the growth of demand, would allow the supply side of the economy some time to catch up, and so act to contain inflationary pressures over time. how, then, do we evaluate the current situation and outlook? most indicators suggest the economy expanded at a moderate pace through the second half of 2006. while housing construction remained a bit below average, engineering and non - residential building have been very strong. consumer demand picked up a little pace, and at present it is being assisted further by the decline in petrol prices. at the same time, the very serious drought has strengthened its grip on the rural sector, and farm production and incomes will be sharply lower this financial year as a result. the demand for labour has remained very strong, with higher than average increases in employment and some further decline in the rate of unemployment through the turn of the year. data on job vacancies and from business surveys suggest little moderation in this area in the near term. looking abroad, the world economy continues to post a strong performance, led by the us and china. many commentators have for some time pointed to the possibility of a sharper -

out of the experiences of the depression in the early 1930s and the major banking crisis in australia in the 1890s. since its establishment as a stand - alone central bank, there have been two key changes to the way the reserve bank approached its financial stability obligations. the first was in the early 1980s when, following the financial system inquiry undertaken by the campbell committee, the australian financial system was deregulated. previously banks had been heavily regulated so were limited in their ability to take risks. in the new deregulated environment, the bank built up a banking supervision framework. prudential standards were introduced and the focus was on the risk management frameworks of the banks. the second key change followed another financial system inquiry undertaken by the wallis committee. as a result of the inquiry, the banking supervision function was transferred to a new institution – the australian prudential regulation authority ( apra ). the reserve bank, however, retained a role focusing on ‘ overall financial system stability ’. how did we interpret this? i think it was set out well in the bank ’ s 1999 annual report, the first year of these new arrangements. the bank stated that its ‘ objective is to ensure that financial disturbances in any part of the financial system do not ultimately threaten the health of the economy. ’ it went on to set out the foundations for financial stability : low inflation ; a safe and robust payments system ; efficient and smoothly functioning financial markets ; and a sound framework of prudential supervision. 1 / 4 bis central bankers'speeches since then, we haven ’ t changed the way we interpret our mandate for financial stability. we are somewhat more explicit about recognising the potential human cost of financial instability in terms of financial distress and unemployment and are more attuned to the behavioural risks associated with risk cultures and financial innovations. but we have substantially increased our communication on financial stability issues. for example, in 1999, when we first started reporting formally on financial stability, we published 10 pages in the annual report, of which only around half were actually an assessment of financial stability. there were six charts – credit spreads in overseas bond markets, credit to gdp, credit growth, house prices, banks ’ impaired assets and risk - weighted capital ratios. in march 2004 when we first published the financial stability review, the assessment was around 40 pages, including over 40 charts, and it is now routinely between 50 and 60 pages with upwards of 60 charts. we also give a lot more speeches covering financial stability issues,