KEY POINTS:
It has been as long in gestation as a baby rhinoceros, but the outcome of the finance and expenditure select committee's inquiry into the monetary policy framework is expected soon.
If a week is a long time in politics, 15 months is an eternity.
The inquiry was launched
against a background where the Reserve Bank had driven interest rates sky high in a bid to deflate a housing market bubble and rein in the associated debt-fuelled spending binge, in the process saddling the export sector with painfully high exchange rates.
But a lot has changed since then.
The housing boom has turned to bust. The world is no longer awash with cheap money; on the contrary, a credit crunch has made the imported savings upon which we rely a lot more expensive.
Interest rates, the dollar and petrol prices are falling. But even with its recent fall, crude oil costs almost twice what it did when the select committee's terms of reference were agreed.
And while inflation then was running at 2 per cent, we are now staring down the barrel of 5 per cent.
The point is that this would be the worst possible time for politicians to undermine the credibility of the monetary policy regime.
The challenge monetary policy faces has switched from dealing with runaway house price inflation and its spillover effects on household debt and consumption to how to keep the lid on inflation expectations in the face of a sustained oil shock.
"The currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation.
"If that were to occur, and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the longer term. A critical responsibility of monetary policy-makers is to prevent that process from taking hold."
These are not the words of Reserve Bank Governor Alan Bollard, though he has made the same point several times in recent months. It was his American counterpart, Federal Reserve chairman Ben Bernanke, testifying to Congress last month.
With inflation across the developed would running at 4.4 per cent, this is not just a local problem.
Under a flexible inflation-targeting regime, such as we have here, the appropriate central bank response to a surge in oil prices is to "look through" it, allow the shift in relative prices to do its work and not tighten policy.
But the caveat - repeated with increasing urgency by central bankers lately - is that that tolerance cannot extent to "second round" effects, where people try to avoid a drop in real wages or profit margins by passing on higher costs to their employers or customers, creating a persistent inflationary spiral.
In embarking on an easing cycle two weeks ago, Bollard is in effect trusting to the severity of the recession and the flexibility of labour and product markets to avert that danger. Much as people might want to pass on higher costs, they might not be able to.
But that is a gamble on his part, because one of the big structural changes which has occurred in the economy has been the shift to a much tighter labour market.
Such is the gap in incomes between New Zealand and Australia, and most other developed countries, that we lose almost as many Kiwis as we gain immigrants. Net migration, while positive, consequently does little to offset the dominant demographic trend of an ageing population.
So unemployment has been low and labour force participation high by historical and international standards. We will get some fresh data this morning on whether that has changed much.
But even if it has and the danger of an old-fashioned wage-price spiral passes, and even if petrol prices continue to fall, the underlying trends look as if they are here to stay.
The challenges posed by a common labour market with Australia will remain. So will an oil price outlook driven by relentlessly rising demand in Asia and a rising cost curve on the supply side, even if there is some temporary relief at the heavy cost of a global economic slowdown.
So can the monetary policy framework cope?
"This framework has worked well ... [It] was designed to have the necessary flexibility to cope with the business cycle, shocks that may occur, the inevitable errors in forecasting and lags in the effects of policy decisions. The framework does not assume that inflation can be fine-tuned over short periods."
Again, these are not Bollard's words, but those of his Australian counterpart Glenn Stevens last month. They are, however, very much in line with Bollard's trenchant defence of the current regime in a speech last week.
He pointed out that real per capita incomes had grown more rapidly in the low inflation environment since 1990 than in the high-inflation 1970s and 1980s.
He pointed out that most developed countries had followed New Zealand in adopting an inflation target for monetary policy and that our target band was a middle-of-the road one.
In an implicit response to Winston Peters he said the "superficially attractive" option of requiring monetary policy to pursue multiple objectives such as growth, employment, exports and the balance of payments had been tried before, here and abroad, and found to result in stop-go policies and high inflation.
Inflation expectations have been on a clear upward trend since the start of the decade, rising from less than 2 per cent then to nearly 3 per cent now in the Reserve Bank's own survey. The National Bank's business outlook survey has expectations higher still.
And with the Reserve Bank itself forecasting inflation to hit 5 per cent in the September quarter (which it hopes will be the peak), confidence that we are still in a low-inflation environment will come under further strain.
Yet even at this delicate juncture it appears that the Government is prepared to undermine that confidence by politicising the monetary policy arrangements.
Associate Finance Minister Trevor Mallard said in Parliament early last month - and not at all off the cuff - that the tools available to the Reserve Bank had not been able to address the inflation challenges presented first by the housing market and latterly by high oil and food prices. "In fact in the first case it could be argued they exacerbated the problem."
The Government was open to looking at alternatives, Mallard said.
But, when pressed the following day about what they might be, he said: "I'm not proposing any change at all and I want to make it absolutely clear no decisions or current proposals are before the Government."
The financial markets seem to have looked at the political polls and Bill English's defence of the status quo and concluded that the issue is moot.
But the risk remains that Labour will have another go at making this an issue of political branding ahead of the the election, sacrifice 20 years of bipartisan support for the inflation-targeting regime and undermine the Reserve Bank's credibility - just when we need it most.
