additional workers employed over that period would not just be lower than average, it would actually be ( approximately ) zero. surely employers would not have taken on people with productivity that low. other hypotheses have been advanced for a slowdown in productivity growth. among them are that higher levels of labour turnover in a tight market disrupt productivity performance across firms ; or that changed regulations ( e. g. new accounting standards, tougher requirements to demonstrate appropriate corporate governance and so on ) are using resources without adding to output. at this point, however, these don ’ t seem sufficient as an explanation for a productivity slowdown of the magnitude we observe in the data. hence it appears that, for the moment, we are left with something of a puzzle. that means that, as usual, monetary policy is being made under conditions of uncertainty. if the gdp data are correct, then the economy grew more slowly than earlier thought in the first half of 2006, potentially with some moderating impact on the outlook for inflation. ( even then, we would still have to ask the further question of whether the slowing was driven mainly by lack of supply or lack of demand. only in the latter case would it mean that spare capacity in the economy will have been increased. ) if, on the other hand, there really has been more growth than the gdp accounts suggest – more in line with the rise in employment and the trend decline in unemployment – then capacity probably remains pretty tight. in that case, upward pressure on inflation remains a distinct possibility. alternatively, if both sets of data are correct, then productivity actually has slowed down considerably. but if that is true, unless it is a temporary phenomenon, then potential gdp growth is not 3 per cent or a bit above any more. it will be less, and our growth aspirations would have to be adjusted accordingly. in this scenario, inflation pressure in the near term could well increase and demand growth may need to be further restrained for inflation to remain under control over time. in trying to assess which of these possibilities, or which combination of them, is in operation, one of the pieces of evidence to which we will be looking for guidance is the behaviour of prices themselves. an economy with genuinely sub - potential growth over two years ought, other things equal, to start putting some downward pressure on inflation fairly soon. an inflation rate that continued to increase, on the other hand, would presumably raise questions about either the apparent rate of growth of demand and output, or of potential

policy with more scope to be flexible in the face of shocks. the past decade has seen no shortage of challenges, often of a financial nature : the asian crisis, the ltcm episode, the dot com mania and subsequent downturn, and so on. when conditions in the real economy were threatened on those occasions by contractionary forces, central banks in a range of countries were able to respond with reductions in interest rates, or by retaining already low rates for an extended period. some people would be inclined to argue about whether or not such actions were in every case ideal. but the more important point is that, without a background of low and steady inflation and wellanchored expectations, they would not have been feasible at all. were the recent higher inflation rates of the past year in australia and some other countries to persist, and to start affecting behaviour, such a degree of flexibility for monetary policy might not be present in future moments of economic difficulty. acting as needed to keep inflation in check in the near term, on the other hand, preserves future flexibility. it is that strategic requirement to which central banks should be, and i believe are, paying close heed. as we do so, of course, we will be bearing in mind the lagged effects of the policy adjustments already made. if we can successfully see off the higher inflation of the past year or so, we will have done a lot to establish the conditions needed for ongoing growth. ‘ economic policies to address global pressures ’, speech by dr ken henry, secretary to the treasury, to the australian industry group national forum 2006, canberra, august 2006 ; available at http : / / www. treasury. gov. au / documents / 1140 / pdf / aig _ august _ 2006. pdf.