indicators. for example, employment growth has been booming throughout the twelve months that gdp has apparently been restrained. the lagging nature of the employment / gdp relationship may explain part of this, but not all of it. there is a similar discrepancy in the comparison with high business confidence, high consumer confidence, increasing business profits, booming share market and government tax receipts. it would be tempting to disregard the national accounts entirely and rely instead on the other indicators of economic activity mentioned above. however, i do not intend to do so. while i think there is some tendency for the national accounts to be understating the level of economic activity at the moment, i think that they are right in the sense that they show that growth has slowed somewhat from 2003 to 2004. the next question is to ask why. this is where capacity constraints enter the picture again. economic policy in australia, most notably monetary policy, has allowed domestic demand over recent years to run at a reasonably fast pace. but as can be seen from the numbers below, this has not been translated into an equivalent growth of output as measured by gdp. table 1 growth of demand december growth of gdp 4 quarter ended growth rate 4. 3 4. 3 6. 7 3. 2 5. 8 4. 3 2004 * 4. 3 3. 0 * 4 quarters to september quarter the most obvious explanation for this discrepancy is one particular capacity constraint, namely that which has restricted the expansion of our export volumes, particularly resource exports. but it is highly likely that other capacity constraints have also begun to operate. for example, the growth of manufactured and service exports has also slowed and this is partly due to the fact that an increasing proportion of existing capacity is used to supply fast - growing domestic demand. after nearly fourteen years of economic expansion, we do not have the spare capacity we once had. looking ahead, we have to recognise this situation. attempting to maintain demand growth at the rates to which we were accustomed would risk a rise in inflation and would probably not result in an appreciable increase in output growth. fortunately, demand has already started to slow somewhat and it is getting closer to the growth of output. despite its growth probably being understated, gdp is also starting to slow under the constraints imposed by capacity limitations. i think we will have to get used to seeing gdp growth rates starting with the numbers 2 or 3 rather than 3 or 4 for a time. on inflation, our forecast a year ago for

. the second risk that i mentioned earlier was a boom and bust in asset prices. i do not think this is a serious risk at the moment, although it was not that long ago that it posed a threat. in 2003, we had both household borrowing and house prices growing at over 20 per cent, and that was on top of several earlier years of strong rises. if 2004 had produced another year of 20 per cent growth, then we would have had the makings of a serious boom and bust situation. as it was, 2004 was a very good year in this respect as borrowing slowed and house prices retreated for most of the year. growth in borrowing seems to have now settled for the time being at a rate of about 13 per cent per annum, and house prices may have risen in the december quarter of 2004. it is too early yet to know where either borrowing or house prices are headed. the third risk i mentioned was the balance of payments, where the current account deficit is estimated to be 6¾ per cent of gdp. this is not very different to the level reached on a number of occasions over the past two decades, but it is disappointing given that it has occurred against the background of a reasonably buoyant world economy and a strong rise in the terms of trade. strong domestic demand pushing up imports is part of the story, but the bigger part is the failure of the volume of exports to rise sufficiently to take advantage of the strong world demand. we have recently analysed this at some length, and presented our conclusions in our quarterly statement. i will be happy to talk about this later in more detail. but while the balance of payments result is disappointing, it is not of itself a reason for a monetary policy response. at this point, i usually look back at the forecasts i gave the committee last time to see how the outlook has changed. i also make a couple of new forecasts. on economic growth, last year was one of the few examples where the growth rate we now expect will be well below what we had forecast. in the middle of last year we were forecasting 3¾ per cent growth for the year to the december quarter 2004 ; now we think that when we receive the december quarter national accounts next month, they will show a growth rate of not much more than 2 per cent. how do we explain the difference? one explanation would emphasise that the national accounts are showing a picture of the economy which is considerably weaker than that shown by most other