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Inflation needs better, balanced control

2 February 2006

Inflation needs better, balanced control

Inflation in New Zealand is not being well controlled and a greater balance between monetary and fiscal policy is needed to put it right, says a Victoria University researcher.

Professor Roger Bowden, of the School of Economics & Finance, has completed a study into inflation control that questions the decision to leave the control of inflation largely to the Reserve Bank.

“Control of inflation has in recent times been driven by the Reserve Bank, with the government’ own stabilisation policy as a back seat passenger. My research indicates that there is a need for a more balanced role as between monetary and fiscal policy.”

Professor Bowden says a key problem is that the Reserve Bank’s official cash rate (OCR) is not an efficient means to control inflation.

“Increasingly, consumer and investment spending are funded by fixed rate mortgages, which are less responsive to the OCR. Liquidity has flooded in from abroad to finance mortgages. Together with the short term OCR, this has jacked up the Kiwi dollar into the danger zone for some exporters, with little effect in the meantime on consumer spending.”

Professor Bowden says the Reserve Bank has to become more adept at handling expectations of future OCR changes.

“This determines currency expectations, for if Japanese investors become concerned about a lower Kiwi in the future, they will demand higher interest rates to fund NZ mortgages.

“As well, we need to realise that devolving inflation control to the Reserve Bank is a convenient model in theory, but unworkable in practice. A more integrated approach is needed, with an explicit stabilisation role for the government. This certainly includes government spending and saving. It also extends to decisions about how and when to issue debt.

“Many of the problems can be traced back to the globalisation of capital markets. Our interest rates are indeed world famous, but not just in New Zealand. Economic policy has to adapt to the new imperatives.”

The paper can be accessed under Working Documents at: www.sef.vuw.ac.nz/vuw/content/display_content.cfm?id=268

ENDS

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