below potential growth, private agents may just borrow to purchase assets in limited or rigid supply ( e. g. real estate property ). in this dynamically inefficient 11 world with structurally weak growth prospects, this may actually become an attractive way for savers to generate returns on their savings that investments in the productive sector are unable to generate. in this case, we end up with a “ rational bubble ”, which – as you will have noticed – follows the dynamics prominently highlighted by jean tirole 12. while unconventional monetary policy is not a necessary condition for this type of bubble to emerge, it may render it more likely – and more violent in the event of its materialising. so what are the consequences of such bubble? in the short - term, it may indeed generate a temporary boost to the economy. and for a while this boost would be difficult to distinguish from the regular workings of asset purchase programmes, which actually embed asset price increases as a desired effect, which passes on the initial impulse to broader financing conditions via portfolio rebalancing. but this boost would ultimately be very costly. not only does it does it come with welfaredecreasing macroeconomic instability, but it also brings about an arbitrary redistribution of wealth that may, in the worst case, undermine social cohesion and trust that the central bank is acting within its narrow price stability mandate. and moreover, it can create financial stability risks elsewhere, generating negative spillovers from what should otherwise be a normal international adjustment process. against this background, it would be wrong to treat bubbles as a welcome replacement therapy to a sustainable growth model. instead, macroeconomic and structural policies have see “ monetary policy in a fragmented world ”, speech by benoit cœure, at the 41st economics conference of the oesterreichische nationalbank, vienna, 10 june 2013. constellations of dynamic inefficiency imply, from a long - run perspective, that the real growth rate exceeds the real interest rate on physical capital. tirole, j. ( 1985 ) : “ asset bubbles and overlapping generations ” econometrica, vol. 53, no. 6 ( nov., 1985 ), pp. 1499 – 1528. bis central bankers ’ speeches to set the necessary conditions so that investment in productive sectors becomes attractive again and investment in bubble - prone areas is discouraged, so that total factor productivity is increased and the natural rate of interest ultimately reverts to what is normal. these principles

the labour market. with this in mind, rba staff are closely monitoring actual outturns and assessing their implication for the outlook for the labour market and inflation. to relate this to the chart, we ’ re evolving our assessment of whether we ’ re on the orange, blue or green lines. and the answer to this question is critical to the board, as a move to the scenarios depicted in green or orange may require a change in policy strategy – i ’ ll return to that point later. higher chinese fiscal spending external risks to the australian economy can also be interrogated with scenarios. at any given time, there are many known external risks ( as well as unknown unknowns ). deputy governor andrew hauser discussed one of the key unknowns, the global trading environment, in his speech earlier this week. 5 another current example of a material external risk is the path of future chinese fiscal policy. china is a large economy and australia ’ s largest export destination, which means its trajectory is important for australian monetary policy setting. one way we have explored that is to consider the effects of chinese fiscal spending being higher than expected. there are several ways this could affect the australian economy : 6 • stronger demand in china increases prices for commodities that australia exports as well as the price of chinese exports to australia. higher commodity prices increase australian corporate profits and government tax receipts, some of which could lead to increased spending. • stronger chinese demand also increases demand for other australian exports. services export volumes are more responsive to demand so there would likely be a direct activity channel for service exports. this could be offset to some extent, however, through adjustments via the exchange rate. • similarly, stronger demand in china lifts activity in china ’ s other trading partners, many of which are important destinations for australian exports. • financial channels impact the australian economy. while direct financial links with china are minimal compared with trade links, chinese activity influences exchange rates and asset prices. a large chinese stimulus package would likely be associated with an appreciation of the australian dollar and potentially boost equity market sentiment. the scenario we consider is a very large stimulus package, beyond what we have assumed in our current baseline forecast profile ( graph 4 ). it is not an outcome we think is likely to be announced in the near term. looking at a large, if unlikely, stimulus gives a sense of what it might mean for the australian economy and also illuminates the channels that would be at play for a smaller stimulus ( graph 5 ). 7