less than in late 2008. graph 4 see “ the australian foreign exchange market in the recovery ”, address to westpac forum, 10 december 2009. while turnover has recovered, the pricing of foreign exchange swaps has been affected by the events of the financial crisis in a more long - lasting way. historically, the implicit cost of borrowing us dollars through the swap market was the same as borrowing directly in the us dollar money market, that is, us dollar libor. covered interest parity held and there was no implicit basis in the foreign exchange swap market. however, during the crisis the basis in the swap market widened considerably implying a large premium for borrowing us dollars under swap ( graph 5 ) : the pricing indicated it was considerably cheaper to borrow us dollars directly in the interbank market than under swap. this basis has narrowed significantly from its peak in late 2008, but remains positive at around 50 basis points. graph 5 the origin of this positive basis is the dislocation in money markets that emerged through 2007 and 2008. 2 prior to the crisis, banks outside the united states – mostly in europe – built up large us dollar asset positions which were funded in part by rolling short - term us dollar borrowing. there was a large maturity mismatch between their short - term funding and their long - term asset positions. in the second half of 2007, the supply of us dollars in the money markets tightened considerably and these banks found it increasingly difficult to borrow the us dollars they needed directly. nor could they sell the assets because of their illiquidity. following the collapse of lehman brothers the situation worsened as general counterparty concerns saw the supply of us dollars in the unsecured money market largely disappear. in response, non - us banks increasingly sought to obtain us dollars via the foreign exchange swap market, but supply of us dollars here was also tight. this saw the basis spike sharply higher in october 2008. under normal conditions, market forces would ensure any price discrepancy would be arbitraged away. however, there were a number of constraints on the ability to arbitrage over this period. increased risk aversion, counterparty concerns and balance sheet losses restricted potential arbitrage activity. further, us institutions with access to us dollar borrowing tended to hold additional precautionary balances to ensure their own liquidity rather than lending in the market. for more analysis of this, see cgfs ( committee on the global financial system ) ( 2010 ), “

. this has obviously changed over recent years, as bank funding costs – and hence mortgage rates – have risen relative to the cash rate. as we have noted many times, the board of the rba has taken account of this in its monthly policy decisions. as a result, the cash rate today is around 1½ percentage points lower than it otherwise would have been. the fact that the bank has offset the effect of higher funding costs on lending rates means that the normal level of the cash rate is lower than it otherwise would have been. a 3 per cent cash rate today is not the same as a 3 per cent cash rate in the past. a more difficult issue to assess is the normal level of lending rates, as opposed to the normal level of the cash rate. it is difficult to be definitive here, but there are a couple of reasons why the normal level of lending rates may be lower, at least for a time, than was the case over the past two decades. the first reason is the international environment. as i talked about in another speech recently, many of the countries that avoided the financial crisis are experiencing uncomfortably high exchange rates and low interest rates. 5 australia is one of these. with the major economies of the world quite weak, most other countries would see themselves as benefiting from a lower exchange rate to boost their exports. but, of course, given that exchange rates are relative prices, not every country can simultaneously have a lower exchange rate. it should not really come as a surprise that countries that are in relatively good shape and have not seen large - scale expansion of the central bank balance sheet are experiencing stronger currencies than those that are in relatively poor shape. this is one of the mechanisms through which the weak conditions in most of the advanced economies are transmitted to the rest of the world. and in response to this, interest rates are lower than they otherwise would be to offset some of the effects of an uncomfortably high exchange rate. the second factor that might have an influence on the normal level of lending rates is related to the issues that i spoke about at the outset. for most of the past 20 years we were benefiting from either the credit boom or the terms of trade boom. under the influence of these two factors, one might expect, all else constant, higher average lending rates than otherwise, as both factors boost aggregate demand relative to supply at least for a period. another way of thinking about this is that in the earlier period there was an increase in the rate