the next year. at the same time, a large buildup in energy and resource sector investment is under way, prompted by optimism about long - run prospects for resource demand. the terms of trade are rising after last year ’ s sharp fall, as the strength of demand has pushed up key commodity prices. in 2010 they could once again reach a very high level, exceeded in modern times only by the extraordinary level reached in 2008. inflation has been falling, in line with recent forecasts. it is important to remember that inflation reached 5 per cent in 2008, or just over 4½ per cent in underlying terms. this was much too high. the earlier period of tight monetary policy, and the weakening in demand in late 2008 associated with the escalation of the financial crisis, has seen inflation come down. over the past year, it was about 2 per cent on a cpi basis and about 3¼ per cent in underlying terms. over the past six months, underlying inflation ran at an annualised pace of under 3 per cent. we think it will be about 2½ per cent in 2010. it is normal, given the lags in these processes, for inflation to keep declining for a while after the economy begins to firm. with the economy having had only quite a mild downturn, however, we start the new upswing with less spare capacity than would typically be the case after a recession. one measure of this is that the rate of unemployment peaked at less than 6 per cent, much lower than we or most others forecast. only a few years ago, unemployment rates like this would have been seen as a good outcome in strong times, let alone in times of economic weakness. the general flexibility in the labour market, including the ability of firms and employees to adjust hours of work, limited the rise in numbers unemployed. but the overall size of the downturn in economic activity also proved to be considerably smaller than thought likely a year ago. this is of course a very good outcome. but it also means that there is less scope for robust demand growth without inflation starting to rise again down the track. monetary policy must therefore be careful not to overstay a very expansionary setting. this situation is quite different from those faced by the major countries. whereas many of them had their worst recession since world war ii, australia probably had its smallest. as such, it should not be surprising that australia was among the first countries to begin to raise interest rates, once it was clear that the danger

glenn stevens : overview of the australian economy and future challenges opening statement by mr glenn stevens, governor of the reserve bank of australia, to the house of representatives standing committee on economics, canberra, 19 february 2010. * * * since we last met the global economy has continued an expansion that started around the middle of 2009. it appears that world gdp grew at an annualised pace of about 4 per cent in the second half of last year. many forecasters now expect a similar result in 2010. international financial markets have generally continued to thaw, with most capital markets functioning again and the use by banks of exceptional support from central banks and government guarantees being wound down. these are, needless to say, very welcome developments. having said that, the situation is not without some challenges. i will mention just two. the first is the two - speed nature of the global recovery. normally after a sharp downturn, the ensuing upswing is correspondingly strong. this has been the case among a number of asia - pacific economies, which take half of australia ’ s exports. the strength is not confined to china : india, korea, singapore, taiwan and others have all seen a significant pick - up in production and trade. in several of these instances the term “ v - shaped recovery ” would be apt. around the region, secularly rising incomes, generally healthy banking systems and relatively low public debt levels allow considerable room for confidence of a sustained expansion in demand. in fact in some cases the issue of overheating is arising and the authorities in both china and india have begun to tighten their policy settings. in the large industrial countries, on the other hand, the rebound has been more tentative, and driven more by the turn in the inventory cycle and temporary policy measures than a strong pick - up in private demand. it is not unusual, at this point of the recovery, for the inventory dynamics to be playing a prominent role in pushing up output. nonetheless, the question is the extent to which a durable upswing in private final demand in the various countries will become established. most observers expect this to be a fairly gradual process, given the lingering effect of the strain on banking systems and ongoing de - leveraging, not to mention the need, at some point, to begin the process of fiscal consolidation. growth in these cases is therefore expected to remain modest and, as a result, these economies are likely to be characterised by a lot of spare capacity and ongoing high unemployment. so the historic shift