putting themselves in a position of vulnerability. this is, of course, our particular experience of the thorny question of monetary policy, debt and asset prices. like other central banks we have grappled with the question of what, if any, response monetary policy ought to make to this situation and, like others, we have not found that question amenable to a straightforward answer. on the one hand, these developments are exerting some expansionary impetus to the economy at a time when global demand conditions are weak. to that extent, they are helpful in avoiding undue weakness in the australian economy. on the other hand, the household sector ’ s ability to cope with some future contractionary shock is probably being impaired, at the margin, as leverage continues to increase. while we do not think that there would be any significant financial sector fragility as a direct result of this increased debt even if house prices were to fall in the near term, we fear that there could still be significant general economic fall out if the economy is subject to some other shock, mainly because household consumption could retreat quite quickly. dealing with all this is still very much a work in progress, but as i reflect on our own experience to date and that of others, a few observations come to mind. first, it is not very helpful to couch the discussion in terms of whether monetary policy should try to prick ‘ bubbles ’. this tends to side - track discussion on to questions like whether we can confidently identify, indeed even define, ‘ bubbles ’, and whether or not aggressive policy action is appropriate if we can. a more helpful way to set it out it is to think about the balance of risks facing the economy : is there something occurring which is increasingly likely to be a misalignment, a subsequent reversal of which could prove to be disruptive? and if so, is there some monetary policy course which, while possibly involving some short - run cost to economic activity, would reduce the risk of bigger loss of economic activity later? can we, to use the popular metaphor, buy some insurance and at what price? second, any response by monetary policy is bound to be relatively moderate, because the uncertainty about the effect of policy on the dynamics of asset prices is considerable. that means that asset prices are still likely to move quite a bit in these episodes. policy ’ s ability to smooth things out is limited ( which is something we already know as a general proposition anyway ). third, i am inclined

housing than the mainland. not unrelated, i presume, is the trend in recent years for net interstate migration to, rather than from, tasmania. literally speaking, according to the national accounts, household spending on consumption has exceeded income for the past three years ( i. e. saving was negative ). this calculation includes an allowance for notional depreciation of the dwelling stock ( which is treated as consumption of capital ), but even in a gross sense, household saving, while positive, has been low. here i separate automotive fuel from the transportation sub - group. 7 / 8 automotive fuel prices had risen by about 23 per cent over the period. but a number of items which are affected by strong international competition had fallen in price. these include most electronics categories, household appliances, clothing and footwear, and furniture. of course, changes in the exchange rate, and in particular an appreciating $ a in 2003, have had an effect here, as have tariff reductions, but there is no doubt that competition from abroad has been intense. so while the growth in demand for energy in china and the rest of asia has added to petrol costs, the rising production of manufactures in those countries has reduced other prices. the total cpi rise over the two years was 5 per cent, or 2½ per cent per year, which is exactly in line with the bank's inflation target. graph 6 we will get an update to this picture when the cpi and ppi data for the september quarter are published. the direct impact of the recent high energy prices will presumably be evident in the result. over a somewhat longer horizon, there might be some indirect impacts of the higher energy costs – through the transport system, for example. just how big these turn out to be will presumably depend on, among other things, whether demand conditions allow businesses simply to pass on energy and transport cost increases, as opposed to absorbing them by finding offsetting cost savings or accepting narrower profit margins. longer term, the question to be asked is whether inflation – be it as a result of rises in energy costs, or from any other source – is likely to diverge persistently from a rate of 2 – 3 per cent. apart from energy prices per se, factors to consider in assessing the outlook will be trends in international prices, the likelihood of temporarily higher cpi rises prompting second - round effects via, for example, higher wage claims or other cost increases, and the strength of aggregate demand in the economy. the bank