KEY POINTS:
Westpac economists are discounting concerns the Reserve Bank is having trouble containing the pace of the economy through the official cash rate (OCR).
Last month Reserve Bank Governor Alan Bollard lifted the OCR from 7.25 per cent to 7.5, aiming to keep inflation between 1 and 3 per
cent. He also complained that banks were giving credit too easily and said he had regulatory powers he could use to squeeze their profit margins.
He said the Reserve Bank was continuing to look at alternative measures.
But Westpac economists Brendan O'Donovan and Dominick Stephens say the OCR has been effective in slowing an overheated economy and there is no need for supplementary instruments. Economic growth slowed to 1.5 per cent at the end of 2006, from 4.5 two years earlier despite a robust world economy, strong NZ commodity prices, a housing boom and fiscal policy turning from contraction to expansion.
"To be able to slow the economy against such a strong backdrop, monetary policy clearly still packs a wallop."
They acknowledged the Reserve Bank had faced some headwinds in getting full traction from its OCR moves, including bank margin contraction, customers moving from floating to fixed mortgages and others extending their fixed-rate terms. But those factors would not prove to be such a problem in the future, so any new OCR moves would have even more impact.
The economists pointed out it was the current interest rate that mattered for new borrowing and saving decisions, not the average rate being paid by other people.
They also questioned how much interest rates were to blame for the strong dollar. The kiwi was a commodity currency, rising when world commodity prices rose, they said. Its rise had been a big factor in keeping inflation low, by making imports cheaper.
Without the inflation-dampening exchange rate, interest rates would have risen much higher this cycle, which probably would have been even less popular than the high exchange rate.
The pair accused the Reserve Bank of being partly responsible for the inflation pressure it was now facing.
With the benefit of hindsight, they said, it made a major policy mistake in 2003 by cutting the OCR from 5.75 per cent to 5 on fears of global deflation, at a time of around 4 per cent GDP, net migration inflows of more than 40,000, core inflation above 3.5 per cent, rising, double-digit house price growth, and falling unemployment.
The mistake of 2003 had affected inflation through to early 2006, with the long and protracted period of high interest rates ever since having been a catch-up.
As for the rise in house prices, they said strong fundamental factors were behind the increase, and most of the rises were justified.
- NZPA
