a situation came along that shifted the mean, the strategy might need to be altered. it might be argued that this is what has happened over the past five years or more. the terms of trade event we have lived through is without precedent in its size and duration, at least in the past century. the exchange rate has responded. notwithstanding that, in my view, the australian dollar is probably above its longer - run equilibrium at present, it is far from clear that we can assume that the mean level we saw in the 1980s to the early 2000s will be the relevant one in the future. in evaluating the merits of intervention, the bank has been cognisant that the current episode is unlike the experience of the first twenty or twentyfive years of the float. some very powerful forces have been at work. a further factor relevant to intervention decisions has been cost. intervening against the australian dollar would have been involved selling australian assets yielding, say, 3 per cent, and buying foreign assets yielding much less – in fact earning almost nothing over recent years at the areas of the yield curve where the bank operates. this “ negative carry ” would be a cost to the bank ’ s earnings and therefore commonwealth revenue. now it might be argued that a negative carry for the reserve bank, and therefore the commonwealth, and an acceptance of the associated very large valuation risks, would be a price worth paying, if it corrected a seriously misaligned exchange rate. if such a policy were effective, it could turn out to be profitable, if a fall in the exchange rate offset the negative carry. the point is simply that costs have to be considered alongside the likely effectiveness. often those who argue for intervention don ’ t work through those costs, or they assume it would be entirely costless. that can ’ t be assumed and the idea should be considered in a cost - benefit setting. overall, in this episode so far, the bank has not been convinced that large - scale intervention clearly passed the test of effectiveness versus cost. but that doesn ’ t mean we will always eschew intervention. in fact we remain open - minded on the issue. our position has long been, and remains, that foreign exchange intervention can, judiciously used in the right circumstances, be effective and useful. it can ’ t make up for weaknesses in other policy areas and to be effective it has to reinforce fundamentals, not work against them. subject to those conditions, it remains part of the toolkit. conclusion when the

is actually rather scant over the floating era as a whole. arguably some of the bigger misalignments occurred under previous exchange rate regimes. but what of recent levels of the exchange rate? they have been blamed for many disappointing corporate results and triggered numerous restructurings, instances of “ offshorings ” and job shedding. the only other factor so frequently offered to explain bis central bankers ’ speeches disappointment is “ consumer caution ”. one can imagine that many people would see this as prima facie evidence of the exchange rate being significantly misaligned. there are a few difficulties in evaluating that claim. first, very high terms of trade can be expected to lead to some loss of “ competitiveness ”, as noted above. just how much of this would be expected depends, among other things, on how permanent the terms of trade rise is, but this episode has been very persistent so far. the euphemism “ structural adjustment ” hardly conveys the difficulties faced by firms and their workforces affected by these forces. but a big and persistent shift in relative prices, which is what the terms of trade shift amounts to, was always going to produce some such effects. a further difficulty in assessing the exchange rate ’ s level lies in that very persistence. the relationship between the exchange rate and the terms of trade has, broadly speaking, continued to hold ( graph 5 ). nothing looks very unusual right at the moment. but this relationship is estimated over a period in which the changes were generally cyclical. it is at least conceivable that a large and persistent rise in the exchange rate may have effects on the economy beyond those discernible from the experience of the past thirty years, if previous rises in the exchange rate were not long - lived enough to cause significant structural change. this is a possibility the reserve bank has noted in the past couple of years. 6 there is at least one more complication in assessing the exchange rate ’ s recent behaviour and that is the extraordinary monetary policy measures that are being undertaken in the major economies of the united states, japan and the euro zone. these too are outside any historical experience. such measures are in place because they are required by the circumstances of those economies, but there is no doubt that they have fostered the so called “ search for yield ”. that, after all, was the whole point. added to this is the lessening, even if only at the margin, of perceived creditworthiness of a number of sovereigns