i would like to say a little more about it today and will divide the subject into two aspects : the shorter - term cyclical fluctuations in household credit growth, and the fact that various debt ratios have trended upwards over time. regarding the first of these issues, the most recent cyclical peak in household credit growth occurred around the end of 2003, when it reached an annual rate of over 20 per cent. since the bulk of household borrowing is housing - related, it is not surprising that this phenomenon was closely associated with a sharp run - up in house prices. nationwide house prices increased strongly for several years up to late 2003, reaching a peak growth rate of around 20 per cent in that year. the increases in credit and house prices were inter - related, with credit availability fuelling the price rises, while rising house prices meant people had to borrow larger amounts to achieve home ownership. much of this behaviour was driven by expectations, particularly in the investor market, of future price gains – the classic definition of bubble - like behaviour. in the period since late 2003, both the housing market and the demand for credit have cooled. nationwide house prices have been broadly flat over the past two years and prices have fallen in sydney. household credit growth has eased back to an annual rate of around 12 per cent. although this might still be regarded as quite high in absolute terms, it is towards the lower end of the range in which it has fluctuated in the past two decades. while there are some tentative signs that credit and housing market conditions have firmed a little in recent months, the risks to the economy posed by the over - heating in housing and credit markets in the period up to late 2003 have eased. households now seem to have entered a period of greater financial caution, and this may act as a restraining influence on the growth of household spending for a while to come. the second issue is the high average growth rate of household credit over an extended period. this is a longer - run issue and one on which it is more difficult to make firm judgments. for more than a decade, household indebtedness has grown at a rate well in excess of the growth in household incomes. this has meant that the aggregate ratio of household debt to household income has trended upwards, as has the proportion of household income required to service the debt, and the gearing ratio ( debt to value of household assets ). simple rules of thumb would suggest that this cannot be sustained indefinitely. yet there are a number

a well - functioning system needs to be able to take risk at a reasonable price. a well - functioning system also needs to be resilient to the shifting flows of capital across borders. collectively, global investors can deploy funds on a much larger scale than many markets can absorb without large price movements. in some countries this has led to discomfort with the free flow of capital. but at the same time, access to foreign capital can help drive prosperity and economic development, and allows people to hold more diversified portfolios. the challenge we face then is to design arrangements that allow us to all capture the considerable benefits that open capital markets can deliver, while minimising the attendant risks. the work on the global financial safety net being undertaken in international policy circles is an important contribution here. one of the questions still to be resolved is how extensive that safety net should be and what form it should take. the financial cycle an important theme of this conference is that of “ financial cycles ”. identifying and understanding these cycles has become an active area both for academic research and policy development. as a concept, the financial cycle has considerable intuitive appeal. it has long been observed that financial systems seem to be subject to boom – bust dynamics. we have repeatedly seen credit and leverage build up over time in response to some initial impetus, only to generate excesses that ultimately unwind, sometimes painfully. one question we face is how to define and measure these cycles. it has become common practice to start by looking at cycles in credit growth. but there are limitations here. not all credit cycles end in a financial crisis ; indeed in industrialised economies, only a minority have done so. and in some cases a period of fast credit growth, followed by a period of slower growth, might be exactly what is required, and so should not be viewed as problematic. bis central bankers ’ speeches this means that we need to move beyond a focus on credit only. in my view, it is probably more useful to start with the question : are balance sheets in the economy being strengthened or weakened? if credit is growing quickly, we need to think about whether the credit is being used to create new productive assets or simply to finance current consumption. the implications are quite different. a protracted period of balance sheet weakening might reasonably be viewed as problematic, particularly if it increases the probability of future balance sheet strains and weak economic growth. so a research challenge here is to find ways of systematically measuring the quality of balance sheets across the economy, taking