to build up the pressure that results in crises and large disruptive adjustments. there is another reason why the performance of the australian economy has become more stable than formerly which is not the result of deliberate policy decisions. i refer to the changed behaviour of our terms of trade, a subject i have spoken of on many previous occasions. the terms of trade is the ratio of the price of our exports to the price of our imports, that is the “ buying power ” of our exports. for much of the 20th century our terms of trade trended downwards because the prices of commodities, which make up much of our exports, failed to keep up with the prices of manufactures, which make up most of our imports. in my view, this trend started to change about 15 years ago, as new sources of low - cost manufactures started to come on stream from asia, particularly from china. now it is manufactures prices that act like “ commodity ” prices, and not just in a trend sense, but cyclically too. you will note from my next graph that in the recent major - country recession of 2001, our terms of trade actually improved. normally, we would have expected them to fall, which would have magnified the contractionary effect of the global slowdown. the second question is why has the australian economy recently shown much more stable behaviour than the much larger and more diversified us economy? this is not what you would normally expect of the two economies on the basis of their size or their history. i think the major reason for this is that the us had an asset price boom and bust - commonly known as a bubble - and we did not. i have already shown the rise then fall in equity prices, profits and business investment in the us and the effect this has had on economic activity. the us economy is suffering from a hangover after the binge ; we did not have the binge and so have avoided the hangover. i would like to say that it was excellent economic policy that prevented us from participating in the binge, but that would be claiming too much. noone really understands the relationship between macro - economic policy and asset price booms and busts well enough to make that claim. the unfortunate fact is that it seems to be possible to experience an asset price boom in an economy where macro - economic policy settings seem to be relatively well disciplined and inflation quite restrained. one thing we do know, however, both from the us experience and the earlier japanese experience, is that once the

##en the likelihood of it remaining high on a persistent basis. but there is also a danger for the global economy. the bulk of the growth in demand for energy and natural resources is coming from the emerging world. continuation of such expansionary policy settings in emerging countries, apart from continuing the recent tendency to overheating in those countries, would presumably foster ongoing rapid growth in demand for natural resources. that would continue to hold up cpi inflation everywhere, but also weaken growth in many industrialised countries. policy - makers in many of the advanced countries, already facing a short - term relationship between growth and inflation that has turned much less favourable, could face some very difficult choices in framing their responses to the circumstances they face individually. what is needed is for emerging countries to adjust their policies according to their circumstances. without that, we risk a new manifestation of the “ global imbalances ”, in which too much of the burden of controlling inflation would be placed on the major advanced countries, where growth is already slowing. put another way, this is in some respects a problem of international policy co - ordination. global monetary policy has been too easy in recent years and that is why we have seen such a major run - up in a wide range of industrial commodity prices. any individual country might wish to treat those increases as exogenous, but they cannot be exogenous for the world as a whole if they are driven mainly by demand, which by and large they have been to date. so, as a number of commentators have been saying recently, global monetary conditions need to be tighter. but the adjustments needed really should take place more in the emerging world than in the united states or europe or japan. it is odd that, in such a circumstance, inflation targeting should be attracting some of the criticisms that have recently been seen, because were it used more widely it would tend to alleviate this co - ordination problem. imagine a world in which all countries of significance had been following a medium - term, flexible target for cpi inflation, coupled with appropriate exchange rate settings. most of them would have been tightening policy in a measured fashion in response to rises in headline inflation over the past couple of years. the result would surely have been that resource and energy prices, and cpi inflation everywhere, would now be lower than they are. even now, the current situation could be handled quite well by widespread use of a flexible inflation - targeting approach. regardless of the precise details of any particular framework, though, what is most