price moving about too much : it is not only domestic prices that matter for price signals to the domestic economy. and, in any case, consumers care about the cost of living ( ie aggregate prices ). regard as the bedrock or base of good economic policymaking - the application of common sense. in circumstances where countries are receiving large capital inflows which are difficult to absorb, the first question might be whether something could be done to slow down these capital inflows without distorting the economy too badly, in order to help the transition process. the sorts of things which might be done here are very intrusive prudential supervision and various rules ( or at least monitoring ) on all those who borrow overseas, if only to try to put some “ sand in the wheels ”. chilean - style capital inflow controls might also be a possibility. direct foreign investment may be easier to absorb ( the goods inflow comes as part - and - parcel of the capital inflow, so the transfer takes place with less upward pressure on the exchange rate ). having done whatever is feasible and sensible to try to rein in the capital flows ( and hopefully make them less volatile by slowing down the herd ), what should be done then? there is little doubt in my mind that the exchange rate should appreciate. this is part of the necessary process of bringing about the real transfer of resources ( a current account deficit ) which is the counterpart of the financial flows. but, to the extent that the exchange rate may well overshoot in this process, intervention is a legitimate policy option. we all know the constraints and difficulties with this. in particular, it is fiscally very expensive. but it can be a useful instrument in the toolbox, for moderate, occasional and discrete use. the extra element which can, it seems to me, be legitimately applied in these circumstances is to be vigilant in the face of asset price rises, and to use whatever instrument ( within reason ) can be used to prevent such bubbles from occurring - prudential rules, taxation, and even the classic fall - back, bureaucratic red tape. of course, there is some hope that the rising exchange rate might discourage the capital inflows ( the textbooks say that it should ), although i have little faith that this mechanism will work at all smoothly, and there is too much evidence of herd and euphoria behaviour to give me any confidence that flexibility in the exchange rate will be an effective break on the

we have the flexibility to pursue our price stability objective while taking into account developments in balance sheets in a way that can be difficult to do in more rigid monetary policy frameworks. so that is australia. welcome. there is a lot to like here. in the spirit of openness and transparency though that i mentioned a moment ago, we are not without our challenges. i will talk about a few of those in a moment. i first want to say a few words about openness to trade and investment and its role in australia ’ s prosperity. 1 / 4 bis central bankers'speeches australia is a country that has benefited greatly from the open international trading system. our ability to sell to the rest of the world goods and services that we can produce really well has boosted our living standards. we also benefit from being able to buy goods produced overseas. and the need to compete with others is one of the things that leads us to strive to do things better. australians have also benefited from the relatively free flow of financial capital. year after year, for more than two centuries now, capital from the rest of the world has helped build our country. if we had had to rely on just our own resources, we would not be enjoying the prosperity that we do today. our asset base and our productive capacity would be lower, and so too would our standard of living. as investors, australians have also benefited from being able to diversify our portfolios by buying foreign assets and by building strong businesses overseas. so, again, that is australia. we provide a very good illustration of how a medium - sized country that is committed to an open international order, has a strong role for markets and a floating exchange rate, a largely open capital account and a dynamic and innovative financial sector can prosper in today ’ s complex world. i promised openness and transparency. so now to some of the issues, or challenges, that we face. the first is to reinvigorate productivity growth. australia, like many other advanced economies has experienced slower productivity growth over the past decade. in our case, this has been partly due to a large increase in mining investment in response to soaring commodity prices. in recent years though, as the new production made possible by all this investment has come on stream, the productivity figures have improved. this is clearly good news, although underlying productivity growth remains relatively modest. a number of structural factors are at work here. if we do not address these factors, then we will have to adjust