the world economy goes into a recession, as the united states and japan have done and much of the rest of the world seems to be doing, does that mean that australia has to follow? people who would answer yes to this question would point out that we have done so in the past, for example, in the mid 1970s, the early 1980s and the early 1990s. why should this time be any different? this is a view of the world that i would call historical determinism, and it may or may not be a good guide. but before we accept such a prediction, it should be challenged by a close examination of the circumstances then and now. what such an examination reveals is that present domestic circumstances are very different to those prevailing in the earlier episodes. to put it bluntly, we brought a lot of the problems on ourselves in the previous episodes, whereas this time we have not done so. on the previous occasions, we could not in all honesty make the claim that it was mainly the fault of the rest of the world – much of the fault was clearly of our own making. in other words, australia had a lot of serious domestic imbalances that contributed to the downturns. imbalances - then and now for a start, each of the earlier downturns was preceded by an episode of high inflation. in the 1970s and 1980s, the cpi was rising in double digits ; in the 1990s, although this measure peaked at a lower rate – about 8 per cent – it was accompanied by unsustainably high asset price inflation. accordingly, monetary policy had to be tightened on all three occasions to combat these imbalances, and short2 term interest rates reached very high levels – either a little above or below 20 per cent on each occasion. nothing remotely like that has happened this time to either inflation or to interest rates. perhaps more importantly, monetary policy this time has been able to be eased much earlier than on previous occasions – interest rates have been successively lowered for nearly a year now, during which the economy has been growing at a good rate. while i think the different behaviour of inflation and interest rates is the biggest change between then and now, there are a number of other factors that contributed to our difficulties in earlier times that are not present now. i have listed these before, but there is no harm in doing so again : • there were large rises in real wages that squeezed the business sector in the 1970s and 1980s. this time wages have grown at

this practice is no doubt designed to please investors and therefore to prop up the company ’ s share price. if these lay - offs are occurring as announced, it suggests a more rapid employment response than in previous downturns. while the practice may help one company when viewed in isolation, it is a serious error to think that companies in general can protect their earnings in this way. earnings are meant to decline cyclically in circumstances such as the present because it is impossible to cut costs as fast as revenue is declining. the more the cyclical fall in earnings is resisted in this way, the more it is transferred to employment, and the more pronounced the cycle becomes. conclusion calendar year 2001 has been a difficult one for the world economy, and the first half of 2002 looks like remaining weak before a recovery gets underway. this would mean 18 months of economic weakness for the world economy, and be classified as a recession like those of the mid 1970s, early 1980s and early 1990s. the australian economy has got through the first half of it in reasonably good shape considering the circumstances. can we keep up our present performance until we are again in an environment of reasonable world growth? can we span the valley? i have given a number of reasons why i think we can, even though we will experience falling exports, falling earnings and the usual inventory adjustments. these are examples of externally - induced contractionary effects that cannot be avoided, but which are not big enough by themselves to cause a recession. for that to occur, we would have to see an over - reaction by domestic consumers and businesses. the evidence to date from surveys of confidence, from household spending and from business investment intentions is that they are holding up reasonably well. far from over - reacting, they are exerting a generally stabilising influence. if this changes for the worse, or if it appears that the outlook for the world economy is weaker than currently assumed, we will be prepared to adjust monetary policy accordingly.