The discussions focused on the policies necessary to reduce inflation, maintain financial stability, and foster strong growth prospects over the medium term.

The IMF found that sound macroeconomic policies and structural reforms within the country have delivered a prolonged expansion, but recently the economy's productive capacity has become increasingly stretched. The commodity driven boom has pushed up against capacity constraints, with unemployment falling to the lowest rate since the mid-1970s and capacity utilization rising to historic highs.

As inflation accelerated over the past year, the RBA appropriately tightened monetary policy, and fiscal policy in the latest budget is providing needed support.

The global financial turmoil that emerged in mid-2007 and the extraordinary jump in Australia's commodity export prices in recent months present additional challenges.

Underlying inflation is the highest it has been since the introduction of inflation targeting in the early 1990s, and monetary and fiscal policy will need to focus on reducing inflation.

The global financial turmoil has illustrated the resilience of Australia's financial system and highlighted the role of the sound macroeconomic policy framework, the flexible economy, and the importance of structural reform.

Australia's Government shares the authorities' view that activity is beginning to slow as required to reduce inflation. Growth in real domestic demand has begun to ease with the rise in debt-service costs, higher energy and food prices, and a decline in confidence.

However, the jump in commodity prices and cuts in personal income taxes will provide support for economic activity.

The IMF's baseline forecast is that real GDP growth will decline below trend for the next two years, easing domestic capacity constraints and returning CPI inflation back within the target band over the next two to three years.

Slowing domestic demand and higher terms of trade should narrow the current account deficit.

Fiscal policy focused on medium-term sustainability has delivered a sequence of surpluses that has eliminated commonwealth net debt.

This leaves Australia with a strong fiscal position, an enviable situation by international standards.

The IMF supports the strategy in the latest budget to save the revenue windfall from the commodity driven boom and thereby allow automatic stabilizers to support monetary policy. Saving some of the revenue from the commodity price boom in three new funds will take pressure off monetary policy in the near term and enable increased infrastructure investment over the medium term.

The reduction in public spending growth in the latest budget illustrates the government's commitment to help reduce inflation. With the upside risks to the outlook for inflation, more public spending restraint could be required and we encourage the authorities to identify areas where additional spending cuts could be implemented.

In addition, positive revenue surprises should be saved to assist monetary policy until it is clear that inflation will decline. Given the uncertainty about how much of the increase in commodity prices will be permanent, saving the additional revenue in the near-term may avoid sharp changes in taxes and spending in the future.

The states have increased capital spending and their budget balance has shifted to a small deficit in aggregate, thereby adding stimulus to the economy.

This highlights the importance of maintaining restraint at the commonwealth level.

To the extent that the improvement in the budget balance is structural, associated with permanently higher commodity prices, this should provide scope to reduce taxes or increase spending over the medium term.

The governments' intention to achieve a positive balance over the medium term should increase public net worth, further strengthening the fiscal position.

The IMF's analysis suggests that a combination of lower labor and capital income taxes, along with increased public investment, will generate the largest economic gains. The gains from other options such as lower consumption taxes or higher public consumption are not as large.

The soundness of Australia's banks was demonstrated during the recent global financial turmoil.

Since banks had minimal exposure to sub-prime assets, the main impact of the crisis was a sharp increase in funding costs. Although the major banks were able to maintain access to offshore markets, the turmoil highlighted financial institutions' vulnerability to rollover risks arising from short-term wholesale funding.

Some of the smaller financial institutions that relied more heavily on capital markets, particularly securitization, for funding were more affected than institutions that had sizable deposit bases.

Nevertheless, banks remain profitable and well capitalized, and asset quality is high by international standards, despite a marginal increase in non-performing loans.

The IMF also supports the planned introduction of new liquidity guidelines that will focus on improved disclosure and stress testing.

These guidelines should further encourage banks to diversify their funding sources and lengthen the maturity of their liabilities. Publication of more detail on the maturity structure of their funding, especially from offshore markets, would impose additional discipline on banks.

Concluding their publication, the IMF announced that they are encouraging the Australian authorities to use the window of opportunity provided by Australia's robust economic performance and the strong fiscal position to advance structural reforms.

The commonwealth and state governments have set ambitious reform programs in areas such as tax reform, competition and regulatory policy, healthcare, education, infrastructure, emissions trading, water management, and commonwealth-state funding arrangements.

It is important that the governments follow through on their commitments to implement reforms.

Successful implementation would enhance the economy's flexibility, lift productivity, and foster labor force participation.