major change to our circumstances was that we now needed to factor in the 2. 2 percentage point subtraction from gdp that was caused by the fall in housing in the second half of last year. why should this be important if it has already happened? indeed, you could make a case to say that if the world economy had continued to grow at the same pace that it did in 2000, the housing effect would have been purely transitory, even if it was much bigger than we or anyone else expected. but the world economy has slowed, which makes this reasoning somewhat academic. it is unlikely that such a large contraction in housing, and attendant falls in demand for those industries supplying the housing sector, could occur without some wider ramifications. i pointed out in my testimony to parliament in december last year that i thought the contraction in housing ( even though i did not know how big it was at the time ) was the major reason for the fall in business confidence. we saw a similar setback to expectations recently when consumer confidence, which had held at above average levels until march, fell sharply in the latest survey, which unfortunately was taken a few days after the release of the december accounts and was heavily influenced by the publicity surrounding it. the other domestic change that influenced our thinking on monetary policy was the lower outlook for inflation. the december quarter cpi followed the pattern set in the september quarter in showing a level of inflation well below our expectation, and implied that our forecasts for inflation would need to be revised downwards. as i have noted earlier, this gave scope for monetary policy to be eased more quickly than would have been possible on earlier occasions. over most of the past 30 years, the classic dilemma for monetary policy was that, even when there was a need to ease on domestic activity grounds, there were often still strong inflationary pressures which cautioned against doing so. one of the many benefits of a low inflation environment is that it restores to monetary policy a degree of freedom that is denied in a high inflation environment. with inflation not imposing a constraint, it has been possible for the bank to respond quickly to the need for a significantly lower level of interest rates. that is, we needed a level of real interest rates that was unambiguously expansionary, just as it had been in the period from mid 1997 to end 1999. the actual mechanics of getting from one level to another is a secondary issue. whether to move by 25 points or 50 points, whether to move between meetings

the extraordinary role of house - building in explaining the weakness of gdp. this was surprising in one sense, because house - building only accounts for 5 per cent of the economy. but its decline in the second half of 2000 was so pronounced that it meant that the figure for the total economy showed a decline of 0. 4 per cent at an annual rate. if we take out house - building and look at how the other 95 per cent of gdp performed, we see that it rose at an annual rate of over 4 per cent. this is much the same as its rate of growth in the previous year. now i do not want to suggest that there was no slowing in some other sectors of the economy, but if it was not for the extraordinary behaviour of house - building, the story would be in line with most observers ’ previous expectations. similarly, the behaviour of aggregate employment in the second half of 2000 can largely be explained by the construction sector and those parts of manufacturing supplying it. table 1 : growth rates four quarters to june 2000 two quarters to december 2000 ( annual rate ) gdp 4. 9 - 0. 4 gdp excluding housebuilding 3. 8 4. 3 why did house - building have this extraordinary pattern? i do not think there is anyone who doubts that it was due to the bringing forward of house - building pre 1 july 2000 to beat the gst, and the subsequent dearth of house - building in following quarters. we all knew this transition effect was occurring, and our forecasts showed substantial falls in house - building in the second half of 2000, but not falls big enough to outweigh everything else that was going on in the economy. the size of these falls was truly outside the range of previous recorded experience, and that is always difficult to forecast. incidentally, similar large shifts in expenditure on housing did not happen in the other countries we had looked at that introduced gst ( see diagram 1 ). diagram 1 let me make a disclaimer before i go any further, lest anyone think i am trying to blacken the name of the gst and imply it was all a horrible mistake. i have always thought that a gst is a good thing for the economy, principally because it could take some of the weight off the high marginal tax rates on middle incomes in australia. i still do support it and note that it will still form an important part of the australian tax system beyond the next election. my only point is that when making a major reform,