The economy's stride has been shortened by weak business investment since the global financial crisis, the Reserve Bank believes.
In its latest monetary policy statement it has lowered its estimate of the rate at which the economy's productive capacity has been growing and is likely to grow.
It now thinks the economy's potential - founded on labour force and productivity growth - increased by an average of only 1 per cent a year over the past three years.
It sees it picking up only to an average 1.8 per cent over the next three years, down from 2.2 per cent in its March forecasts.
This matters because it reduces the amount of spare capacity in the economy and brings forward, all else equal, the point at which inflationary pressures start to mount and interest rates have to rise.
Governor Alan Bollard said the country had been through a long recession with "very repressed" investment in capital plant. "And that does take a toll on productivity."
Potential growth cannot be observed and measured directly. It has to be inferred from indicators of business investments and of the state of the labour market, not only in headcount terms but allowing for mismatches between the skills available and those the firms require.
"It could be we have a higher potential than that but we are taking a fairly cautious approach," Bollard said. "We have been scarred by the global financial crisis and seen lower investment through it. "It could take some time to build up capacity and get potential growth back on to the pre-GFC track."
In the meantime the bank has cut its forecast of actual growth, reflecting a steady stream of generally bad economic news since the previous forecasts in March. Then it expected growth to average just over 3 per cent over the next three years; now it is forecasting just under 2 per cent.
The forward track for short-term interest rates it has pencilled in imply no increase in the official cash rate until this time next year, and only a gentle tightening - a cumulative 75 basis points - over the next three years
The forecasts assume Europe will "muddle through", with just small crises. But the bank is watching developments there intently.
It puts about a 30 per cent chance on Greece exiting the eurozone and a 10 per cent chance of wider exit by other peripheral countries, Bollard told Parliament's finance and expenditure committee.
"The real concern is could a Greek exit spark off contagion in other peripheral countries which are bigger and more important and where liabilities are held by German and French banks," he said.
"I'm talking about Spain and Italy. We think there is a small chance of that but it is absolutely a real chance."
In that event, were funding markets to close up, causing stress in the New Zealand banking system, the Reserve Bank would put in place liquidity measures it used during the global financial crisis.
They were used only to a small extent and worked well, Bollard said.
In the meantime, New Zealand banks were well funded and willing to lend, as evidenced by vigorous competition in the mortgage market.
Apart from the European crisis, the other negative factors in the forecasts are falling export commodity prices and the Government's fiscal policy which will also subtract from growth in the years ahead.
Two offsetting positives are the rebuilding of Christchurch and a pickup in the housing market.
While the chances of another housing boom are remote at this stage, the bank believes, the longer mortgage rates remain at what are historically very low levels the greater the risk of one becomes.
"We will definitely be watching that," Bollard said. "Were we to see anything like the activity we saw during the 2000s housing boom, we would look at additional tools, just as an additional way to [maintain] financial stability. But that is some way off.
"We think orthodox monetary policy would be very effective at the minute given that New Zealanders are very cautious and they are generally on either floating or very short-term interest rates. So, were that to be required, an increase in the OCR, we think, would have quite an impact. It is not on our horizon at the moment."