bank has published an analysis of funding costs, which provides a useful framework for thinking about these issues, so i won ’ t go into them in detail. 1 i will simply make a couple of observations. first, during the easing phase, interest rates for most borrowers still came down quite significantly, because the cash rate changes were so large. for mortgages, floating rates in the past year reached their lowest level since 1964. at the margin, the cash rate cuts were larger than otherwise because the board could see that spreads between intermediaries ’ rates and the cash rate were tending to widen. likewise in future decisions, the board will take careful note of any tendency for spreads to change. davies m, c naughtin and a wong ( 2009 ), ‘ the impact of the capital market turbulence on banks ’ funding costs ’, rba bulletin, june, pp 1 – 13. available at < http : / / www. rba. gov. au / publicationsandresearch / bulletin / bu _ jun09 / impact - cap - mkt - turb. html > second, in australia, housing loan rates came down much more than has been the case in many countries. this was partly because of the prevalence of floating rate housing debt here, but also because spreads on housing loans ( relative to the policy rate ) widened by less in australia than other countries. that is to say, monetary policy still works pretty effectively in australia. the conduct of policy during the crisis going into the crisis, the global economy had been growing strongly. global gdp expanded by 5 per cent in 2007, which capped off several years of well above average performance. the us economy had been slowing for a while as concerns mounted over the financial problems, but even into the first quarter of 2008 global gdp was still expanding at 4 per cent. prices for most commodities were still rising ; oil prices would not reach their peak until july that year. our economy was operating at full stretch, with our terms of trade showing their largest rise in 50 years and delivering a very large income gain to the community. confidence was high ; firms routinely complained of labour shortages ; inflation was tending to rise, worryingly so in the second half of 2007 ; and demand for credit was strong. in this environment, the board was running tight monetary policy to contain inflation. we now know ( but could not know for sure at the time ) that cpi inflation was on its way to 5 per cent. measures of underlying inflation,

to all the above, every three months the bank publishes an extensive analysis of the economy, financial markets and the issues for monetary policy. this document, the statement on monetary policy, typically runs to about 70 pages. all of this is already known. the point of recounting it is to reassure people that there is a very careful, detailed and extensive process involved both in making the monetary policy decision and in explaining it. the transmission process a lot of effort goes into the policy decision, as i have just described. but that only establishes one interest rate in the economy – and a very specialised one at that. ( for today ’ s purposes only, i am leaving aside the other channels through which monetary policy affects the economy, such as the exchange rate, inflation expectations, the supply of credit and so on. these remain important, but today it is the interest rate channel on which i want to focus. ) the “ cash rate ” is the rate for borrowing large parcels of cash, or settlement funds that are held in banks ’ accounts at the rba, overnight. this is a very active market, but only a very small proportion of borrowing in the economy is actually conducted in this market. to have its broader effect, monetary policy relies on changes in the cash rate affecting other interest rates. both today ’ s cash rate and its expected value over the next six months to 12 months form the anchor for the spectrum of interest rates in the economy. but there are other factors at work as well. term premia – the additional return that must be paid when money is tied up for longer periods – and compensation for risk also can affect the official yield curve and the structure of private interest rates. for some years, these other factors were reasonably stable. compensation for risk actually tended to decline gradually, as a result of a very strong “ search for yield ” by investors and heightened competition among intermediaries to lend. hence in net terms loan rates slowly fell, relative to the cash rate. on the whole, though, changes in the cash rate came to be seen as driving most of the important rate changes in the economy quite precisely. this was, historically speaking, somewhat unusual. in the past 18 months or so, in contrast, a sharp reappraisal by investors around the world has seen compensation demanded for accepting risk increase. as a result, the various market interest rates that intermediaries have to pay to raise funds have, on occasion, moved independently of the cash rate. the