objectives. the connection with the second objective – full employment – is obvious. the rba is seeking to achieve the lowest rate of unemployment that can be sustained without inflation becoming an issue. in doing this, one of the questions we face is what constitutes full employment in a modern economy where work arrangements are much more flexible than they were in the past. i will return to this issue in a moment. the labour market is, of course, also central to the third objective in our mandate – our collective welfare. it is stating the obvious to say that for many australians, having a good job at a decent rate of pay is central to their economic prosperity. trends in the labour market also have a major bearing on inflation outcomes, so they are important for the first element of our mandate as well. over time, there is a close link between wages growth and inflation. and a critical influence on wage outcomes is the balance between supply and demand in the labour market ; or in other words how much spare capacity is there in the labour market? this question is closely linked to the one about what constitutes full employment. so, it is natural that we focus on the labour market as the board makes its monthly decisions about interest rates. spare capacity with that background i would now like to discuss how we assess the degree of spare capacity in the australian labour market. i will do this from four perspectives : 1. the rates of unemployment and underemployment 2. the flexibility of labour supply 3. the effectiveness with which people are matched with job vacancies 4. trends in wages growth. unemployment and underemployment the conventional measure of spare capacity in the labour market is the gap between the actual unemployment rate and the unemployment rate associated with full employment. even at full employment, some level of unemployment is to be expected as workers leave jobs and search for new ones. as my colleague luci ellis discussed last week, we don't directly observe the unemployment rate associated with full employment – we need to estimate it. [ 1 ] over recent times there has been a gradual accumulation of evidence which has led to lower estimates. while it is not possible to pin the number down exactly, the evidence is consistent with an estimate below 5 per cent, perhaps around 4½ per cent. given that the current unemployment rate is 5. 2 per cent, this suggests that there is still spare capacity in our labour market. the fact that the conventional estimate of spare capacity is based on the unemployment rate reflects an implicit

confidence one has at longer horizons should be much lower than at shorter horizons. because i do not know what the federal funds rate target range will be at the end of 2017 or 2018 with any confidence, i am not very concerned if others have a different modal forecast. projections will adjust as incoming information changes the economic outlook. i would expect convergence over time of the sep and market expectations as new information informs the outlook. bis central bankers ’ speeches let me close with some observations about my current thinking concerning our reinvestment of maturing treasury securities and paydowns in our agency mbs holdings. as we noted in the december fomc statement, we anticipate that we will continue reinvestment “ until normalization of the federal funds rate is well underway. ” i think this policy makes sense not only because the decision to end reinvestment will represent a further tightening of monetary policy, but also because it is difficult to assess ahead of time the impact of such a decision on financial market conditions given the lack of historical experience. i also believe that continuing reinvestment until the federal funds rate reaches a higher level makes sense. we want to ensure that we have the ability to respond to adverse shocks by easing monetary policy by lowering the policy rate. having more “ dry powder ” in the form of higher short - term interest rates seems more desirable than less dry powder and a smaller balance sheet. now the words “ well underway ” in the fomc statement are vague – what does that mean in terms of the level of the federal funds rate? reiterating the disclaimer that i am speaking for myself, my view is that we should not set a numerical tripwire for ending reinvestment. if the economy were growing very quickly and the risks of an early return to the zero lower bound for the federal funds rate were deemed to be low, then i could see ending reinvestment at a relatively low federal funds rate. in contrast, if the economy lacked forward momentum and the risks of a return to the zero lower bound were judged to be considerably higher, i would want to continue reinvestment until the federal funds rate was higher. consistent with the general principles i mentioned before, the evolution of the overall monetary policy stance – both interest rate decisions and balance sheet developments – should be data dependent. in my view, good monetary policy - making requires ongoing assessment and judgment, not the adherence to mechanical rules. i know market participants desire certainty, but in the uncertain world