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Major shocks pose policy challenge

Reserve Bank Email Service

Date 25 January 2008
Time Embargoed to 1:30pm

Reserve Bank says major shocks pose policy challenge

Economic policy has to be alert to emerging shocks to the economy, and how they might affect price stability and growth, Reserve Bank Governor, Alan Bollard, said today.

In a speech - entitled Coping with Shocks - a NZ Perspective - delivered to the Canterbury Employers' Chamber of Commerce in Christchurch, Dr Bollard said that over the past few years, New Zealand has come through significant global shocks, and there is no sign of these abating.

He said that, despite these shocks, the New Zealand economy has responded positively.

"We have enjoyed a decade of growth, the longest period of economic growth since the post-World War II era. Inflation has been low, averaging 2.2 percent since 1998.

"However, neither the current global expansion nor price stability - known internationally as the "Great Moderation" - can be taken for granted," he said. "Over recent years inflation has averaged in the top half of the Bank's target range of 1-3 percent, due to higher demand fuelled by the economic expansion, and because of supply-side cost shocks."

Dr Bollard highlighted a number of international price shocks that have posed key policy challenges: the surge in oil prices; a wider commodity price boom; the global housing market boom and its after-effects; the consumption boom in advanced economies; and efforts to offset climate change.

"Inflation pressures in New Zealand have been significantly boosted by the shock to personal consumption from the housing boom and the rundown in household savings. Soaring global dairy prices have added to these pressures by boosting farm incomes. Higher prices for oil and other imported raw materials have also contributed through higher production costs. Soon New Zealand will be hit with yet another price shock as a result of the Emissions Trading Scheme."

Many of these challenges and associated price pressures are associated with the growing international presence of China and other emerging market economies. The financial market instability emanating from the sub-prime US mortgage market represents the most recent emerging threat to economic growth.

"The current financial market turbulence is a timely reminder of both the interconnected world we live in, and how quickly events can unfold," Dr Bollard commented.

Since the December Monetary Policy Statement there has been ongoing turbulence in international financial markets and a deterioration in the outlook for the United States and European economies.

"We will be watching these developments closely, particularly their implications for the Asian and Australian economies and for world commodity prices."

Dr Bollard said monetary policy has to be constantly tuned to handle large changes in our economic conditions such as these, so we can manage the inflationary effects arising from shocks.

"Our inflation targeting framework is robust and well-placed to deal with these challenges. We have been able to absorb recent shocks reasonably well because of the improvements in our economic institutions and policymaking frameworks, avoiding the boom-bust cycles of the 1970s."

Dr Bollard said that all economic players - firms, households and governments - make decisions that can affect how a shock affects the economy.

"Those decisions need to be made with the best interests of growth and stability in mind," he said.

The speech can be viewed at the following link


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