in a number of other advanced economies, including the united states, there is currently little net growth in the capital stock, with the investment that is taking place barely enough to offset depreciation. the fact that investment is high in australia reflects the high expected return on capital, particularly in the resources sector. given that countries with relatively high returns on capital typically have relatively high real interest rates, it should not be surprising that interest rates in australia are above those in other countries where the return on capital is currently much lower. in terms of productivity, the story is not as positive, although, as always, measurement issues cloud the picture. according to the australian bureau of statistics ( abs ) data, since the mid 2000s, almost all the increase in output in australia has been accounted for by a rise in hours worked and an increase in the capital stock. or put another way, there has been very little underlying productivity growth over this period ( graph 4 ). the reasons for this are not particularly clear. some slowing in productivity growth might have been expected in the mature stage of the business cycle, as the economy was operating against its capacity limits and skill shortages emerged. a second possibility, relating to the mining sector, is that high commodity prices allowed lower grade resources to be mined. the lag between the construction and production phases of large resource projects may also have lowered measured productivity growth, at least until these projects come on line. more generally though, it is important to remember that one of the least productive things that a society can do is to leave large numbers of people sitting at home who actually want to work. from this perspective, the productivity performance over the past decade looks to be quite a lot better. the australian economy has done well at bringing in to paid employment those who actually want to work and the unemployment rate has fallen significantly. while one side effect of this may have been to contain productivity growth as conventionally measured, from a broader perspective it represents a considerable success. as we go forward, if we are to grow strongly on a sustainable basis we will need to ensure that both our capital and our workforce are used as efficiently as possible. returning to my earlier theme, maintaining flexibility in the economy is important here. under the central scenario that i sketched earlier, the economy is likely to undergo considerable structural change, particularly as the resources sector expands. how well we deal with this change will have a significant impact on how the overall economy performs. housing now to the second issue, that of housing

policy had to respond to changes in this environment. without both of these aspects, the recent economic history of australia would have been quite different. this flexibility, though, did not just materialise out of thin air. instead, it was the result of many years of policy reform and hard work by governments and business. what we have seen recently is the dividend of that hard work, with the economic outcomes over the past year or so reflecting not just the decisions made since late 2008, but also the decisions made in the two to three decades before that. i would like to touch on a few aspects of this flexibility. the first is the flexibility of the exchange rate. this has been one of the great success stories of economic policy making in australia. without it, we would have seen bigger booms and busts and more variable and, probably, higher inflation. as ric battellino, the rba ’ s deputy governor, discussed in a speech a couple of weeks ago, the floating exchange rate has helped the economy adjust more smoothly to the current boom in the resources sector than was the case in previous resources booms, which always ended in high inflation. it also helped the economy in 2008 when global risk aversion was at its peak, and during both the asian financial crisis in the mid to late 1990s and the bursting of the tech bubble in the united states a decade ago. the second area is labour market flexibility. over the past year, the unemployment rate rose by considerably less than was expected. while this was partly the result of the surprising strength in the economy, it also highlighted the increased flexibility of the labour market. when demand weakened, many firms and their employees agreed to reduce working hours as a way of preserving jobs. and in other cases, wage rises were reduced or delayed as a way of avoiding lay offs. these responses helped limit the rise in the unemployment rate. in turn, this helped support incomes and the general level of confidence in the community, and ultimately the level of economic activity. the third area is the flexibility in macroeconomic policy. when the world economy took a sharp turn for the worse, fiscal policy in australia responded quickly and on a significant scale. it was able to do this without raising the fiscal sustainability concerns that have come to the fore in a number of other countries. while there will always be differences of opinion about the merits of specific measures, there is little disagreement with the idea that australia ’ s history of sound fiscal policy provided the government with the