Brian Fallow: Reserve Bank chooses the lesser of two evils

The Reserve Bank leopard has not changed its spots.

When Alan Bollard was appointed two-and-a-half years ago, the governor's mandate from the Government was made more liberal.

Not only was the inflation target band raised to between 1 per cent and 3 per cent, the edges were softened.

Bollard is required only to keep inflation in that range on average over the medium term.

It is a mandate for him to give growth a go.

It was a response to the perception, unjust as it may be, that the bank under Don Brash was so jumpy about inflation that it stepped in to stifle any decent economic recovery in its crib.

And Bollard has lived up to that more relaxed mandate. Indeed, some economists would argue that last year's unsustainably fast economic growth (5 per cent or so, the official score is not in yet) reflects a perilously loose monetary policy.

But yesterday's call - the toughest of his tenure so far - was a choice between two evils.

One is the risk of making the economic slowdown, which is clearly still a-coming, steeper than it need be.

In this scenario, instead of the soft landing the bank forecasts, the economy would drop from the sky with a thud as the combined effects of higher interest rates, a sky-high exchange rate, dwindling migrant inflows and falling house prices come together.

From Bollard's point of view that is the lesser evil, compared with the risk that a sustained period of inflation at or above the top of his target range will undermine confidence that New Zealand is a low-inflation economy.

Maintaining that confidence, that credibility, is still the bank's bottom line, as it was in Brash's day.

Bollard denied that yesterday's move was a shot against the bows of the unions seeking a minimum 5 per cent pay rise. "We don't see ourselves as a warship," he said.

"But it is important the people of New Zealand realise that inflation will not be allowed to get away.

"It doesn't matter who those people are. What is important to us is that we have inflation expectations anchored and we keep it that way."

With the tightest labour market in a generation it is inevitable that wages will continue to rise.

"We don't have a picture of those numbers running away on us at all."

It is those skills which are in very short supply that are being bid up aggressively. That does not necessarily spread much wider around the economy.

Wage rises, by themselves, are not a problem for the bank. They only become a problem if they push up consumer prices .

If wage increases are matched by productivity gains they do not push up unit costs.

Even if they are not warranted by productivity improvements, they are still not a problem for the bank if they come out of employers' profit margins. Those have grown fatter, to judge by the burgeoning company tax take.

But the risk of a return to anything like the old-fashioned wage-price spirals of cost-plus days is not one an inflation-targeting central bank will take.

It may be a kinder, gentler bank.

But that has not changed.