. one of the reasons it has worked well is that it has two essential ingredients. the first is the commitment to the mean inflation rate being at the target. that has been achieved, with medium - term cpi inflation rates averaging close to 2½ per cent. the second ingredient is a sensible approach to variance of inflation around that mean. the framework was designed to have the necessary flexibility to cope with the business cycle, shocks that may occur, the inevitable errors in forecasting and lags in the effects of policy decisions. the framework does not assume that inflation can be fine - tuned over short periods, nor does it require us to attempt rapidly to correct deviations from the 2 - 3 per cent range, which have occurred several times over the period since 1993. this flexibility was envisaged from the beginning in our approach to inflation targeting. the reserve bank quite deliberately eschewed the narrowly defined targets with “ electric fences ” that were initially favoured in some other countries and that were at one stage proposed here. we have made use of that flexibility repeatedly, and are doing so again now. the inflation outlook i have just sketched out would be a pretty long period of divergence from the target. it is important to recall, though, that we have experienced reasonably lengthy deviations before. annual cpi inflation was below 2 per cent for 10 quarters between the middle of 1997 and the end of 1999. 2 if the may 2008 forecasts turn out to be right, then the current episode would entail nine quarters with year - ended inflation above 3 per cent. if we can achieve something like that outcome, that would still be consistent in every essential respect with the experience under inflation targeting since it began 15 years or so ago. as always, the challenge is to combine the right degree of flexibility in approach with sufficient confidence that the inflation rate will be on a declining path over time as to keep expectations anchored. this challenge is not trivial on this occasion. we are, of course, fully aware of the possibility that people may fear that this temporary period of high inflation could, in fact, turn out to be persistent. expectations of high inflation can be self - fulfilling if individuals and businesses behave accordingly. one possible channel people have mentioned is that of higher wage claims, pursued as a result of the pick - up in cpi inflation, which then add to costs and prices, and so on. but i think it should be stated that while there are some signs of that around the edges, growth in overall wages

has thus far remained contained, even though the labour market has clearly been at its tightest for a generation. relative wages are showing noticeable variation across industries and regions, as would be expected given the events in the economy. but overall growth of wages, as measured by all the formal statistics at least, has to date been pretty well controlled. furthermore, if the recent signs of moderation in the demand for labour continue, which could be expected if overall demand remains on a slower track, that should help to contain any over - exuberance in wage setting. so i think that our chances of keeping inflation low over the medium term are good. this outlook does involve a period of significantly slower growth in demand in australia than we have seen over the period up to the end of 2007. the bank has been candid about that. but controlling inflation has always involved being prepared to slow demand, for a while, when needed. not taking adequate steps to that end would have costs. one is that were we to see inflation become established permanently at higher levels, then over time the whole structure of nominal interest rates would reflect that new reality. the mean interest rate would rise. in that world, the interest rates we see now would not look unusually high. they, or even higher rates, would look pretty common. that is what happened in the 1980s, as a result of the fact that we did not control inflation in the 1970s and early 1980s as well as we should have. needless to say, it is that world that we are seeking to avoid. by the same token, there will be a continued pay - off to control of inflation. a stable currency is one of the foundations on which a well - functioning modern economy rests. it is a prerequisite for sustaining growth in living standards. on the interest rate front, moreover, containing and reducing inflation over time will mean that we should be able, at some point, to look back to the current period as one of higher - than - normal interest rates. interest rates, cpi inflation excluding interest charges prior to the september quarter 1998 and adjusted for the tax changes of 1999 - 2000. unlike many other prices in the economy, do not always rise. provided inflation is successfully controlled, interest rates go up and down around a fairly stable mean. conclusion i have dwelt today on challenges facing macroeconomic policies and particularly monetary policies, both abroad and at home. these challenges look more difficult than they have been for a while. of course,