target was at risk in the medium term sense to determine the appropriate policy response. that episode went a long way to enhancing the credibility of the framework with wage and price setters as well as with financial markets. it also increased the confidence within the bank that the inflation - targeting framework would be successful in achieving the bank ’ s legislated goals. the asian crisis and exchange rate shocks at the onset of the asian crisis, the australian economy was growing at around trend rates, with domestic demand beginning to accelerate, and underlying inflation at 1. 6 per cent. monetary 6 / 14 bis central bankers'speeches policy had been eased over the prior year or so in anticipation of the decline in inflation that subsequently occurred. thus the asian crisis hit the australian economy at a time when it was in reasonable shape with the stance of monetary policy already relatively expansionary. exports to east asia accounted for around one - third of australia ’ s exports at the time. in the year following the onset of the crisis, australia ’ s exports to the region declined by nearly 20 per cent, directly subtracting around 1 percentage point from aggregate growth. thus the decline in output in the east asian region represented a significant negative demand shock to the australian economy. australia ’ s terms of trade also fell sharply as commodity prices declined, further exacerbating the decline in export demand. in the event, inflation in australia rose by less than was forecast, in part because of the decline in the pass - through of the exchange rate depreciation, as well as a greater - than - expected disinflationary impulse from the asian region that put downward pressure on import prices. if policy had been set to ensure that inflation did not rise above 3 per cent, the necessary rise in interest rates would have exacerbated the contractionary shock to foreign demand. with the benefit of hindsight, given the lower - than - expected inflation outcomes, this would have resulted in a significant undershooting of the inflation target. the flexible inflation target served as a useful framework to think about the asian crisis. strong consideration was given to the goal of output stabilisation because the inflation target in the medium term was not felt to be in jeopardy. in addition, the policy credibility that had built up since the adoption of the inflation - targeting regime also allowed the reserve bank greater flexibility in its policy response. gst 2000 on 1 july 2000, a 10 per cent goods and services tax was introduced. as a result, the price

not likely to offset the costs of occasional disinflations following positive price level shocks. another challenge is how fast the price level should be returned to its target level. this presents both a communication and operational challenge as the speed is likely to vary with the size of the deviation. while the argument at the moment is that a price level target allows the central bank to let the economy grow more strongly after a period of unexpectedly low inflation, again i do not think that practically this will deliver better outcomes than a flexible inflation target. that is an empirical question in the end which is worth testing. the appropriate level of the inflation target is currently being debated in some parts of the world, including the us. the argument for a higher target rate of inflation is that it might reduce the risk of hitting the zero lower bound because a higher inflation rate would result in a higher nominal interest rate structure. in thinking about this, we should ask the question as to whether what we have seen is the realisation of a tail event in the historical distribution of interest rates ( for a given level of the real interest rate ).? while this event has now lasted quite a long time, if you thought it was a tail event, then you would expect the nominal rate structure to revert back to its historical mean at some point. if it is a tail event, and the world has just been unlucky enough to have 11 / 14 bis central bankers'speeches experienced a realisation of that tail event, then there would not obviously be a need to raise the inflation target. we also need to question whether the real interest rate structure has shifted lower permanently, because of permanently lower trend growth say, which would also shift down the nominal rate structure and increase the likelihood of hitting the zero lower bound. also, as with price level targeting, in thinking about this question, it needs to be taken into account that it is highly beneficial to have the inflation target at a level where it doesn ’ t materially enter into economic decision - making. two to three per cent seems to achieve that. we know that some number higher than a 2 – 3 per cent rate of inflation will materially enter decision - making, because we have had plenty of experience of higher rates of inflation that demonstrates that. how much higher though, we don ’ t really exactly know. another consideration in answering the question of whether the inflation target is at the right level is the range of policy instruments in the tool kit. over the past decade, this