on a nominal variable such as inflation because this maximises the chances of achieving sustainable economic growth. sustainability is the key concept here ; attempting to maximise growth in the short run is counter - productive, as is exclusive concentration on trying to smooth the business cycle, or the attempt to get the economy on to a trend growth path higher than its potential. i have no wish to argue with any of these propositions, and indeed they are all encompassed within our inflation - targeting approach to monetary policy. they are admirable statements of the aims of monetary policy, but they are not descriptions of what good monetary policy in a healthy economy would look like, i. e. they do not tell us how the instrument of monetary policy would behave. perhaps it is best to start at a very simple level. most people do not like very high interest rates and associate them with bad monetary policy. of course, if the country is already experiencing high inflation, the high interest rates may be a necessary evil, and the alternative would probably be a lot worse in the long run. be that as it may, we can hardly say that such a situation could be described as good monetary policy in a healthy economy, because the economy is not healthy - it is suffering from high inflation. this all seems pretty obvious, but the obverse is not so obvious. i sometimes hear people say “ why don ’ t we have lower interest rates like country x? ” as though the lower the interest rate, the better off we would be. on closer examination, we see that very low interest rates, although they may also be a necessary evil in the circumstances, usually indicate an unhealthy economy - one that is in recession or, even worse, deflation. we do not have to look very far to see examples of this over the past few years. so if very high is bad, and very low is bad, is there not a happy medium somewhere? is this how we would recognise good monetary policy in a healthy economy? the answer is yes - that is certainly part of the story, but only part. i would now like to go on and tell the rest. twenty or thirty years ago if we had asked my simple question, the answer would have been something like the following. if the potential growth rate of the economy is, say, 3½ per cent per annum and the desired rate of inflation is 2½ per cent, then the long - term trend rate of growth of nominal gdp will be about

monetary policy has to be directed towards how the average of the whole economy is evolving, not to what a particular sector is doing. although we should not allow our perceptions of developments in the housing sector to determine our stance on monetary policy, in our view that does not mean we should remain silent on the subject, and we have not. the situation over the past 18 months, where more than half of the total increase in housing loan approvals has gone into the investor market, is a very unusual one. when we see that this is occurring against a background where vacancy rates are rising, rents are stagnant or falling, and a large increase in new supply is coming on stream, it suggests to us a mis - allocation of investment, and the likelihood of a shakeout in the market, at least in the major cities. if that is to occur, it is better that it occur sooner rather than later. conclusion my main conclusion is that in assessing monetary policy, it is important to see it in a medium or longterm perspective. it is also important not to get the impression that monetary policy is only exerting an influence if it is changing. it is true that monetary policy only makes news when it is changing, but its influence is really the result of what the level of interest rates is. it is quite easy to conceive of situations where monetary policy has not been changed for a considerable time, but where the level of interest rates is exerting a strong expansionary or contractionary effect on the economy. once we recognise that the level is important, we inevitably have to ask what we should compare the current level with, and this leads us to think of the concept of normality or neutrality. of course, we only expect interest rates to be normal in periods when the economy is operating in a normal or healthy way. in situations where it is under either sustained inflationary or disinflationary pressure, there are more important matters at hand than to ponder such theoretical concepts as the neutral level of interest rates. fortunately, the australian economy is in that small group of countries that can rightly be described as operating in a normal or healthy way ; in fact, in many ways, we are the best example around at present.