Brian Fallow writes that several factors will influence how often Bollard taps the brakes.
As the Reserve Bank begins to raise interest rates - if not today, then soon - attention naturally turns to how far the process might go.
There is not much comfort in Governor Alan Bollard's assurance last month that he does not expect the official cash rate to rise as
far in this cycle as it did in the last one: that was to an eye-watering 8.25 per cent.
At this point, the money markets are pricing in 160 basis points of tightening over the next 12 months, implying an OCR of either 4 or 4.25 per cent by this time next year, and further increases to around 5 per cent by the end of 2011.
That is about where some economists, ANZ's for example, see a neutral OCR, neither stimulatory nor contractionary.
It is not a number to be dogmatic about. What we can say (as question-dodging politicians like to say) is that several factors will drive how far rates rise:
How hard will the bank have to lean against rising inflation expectations?
How much has the economy's potential growth rate, its speed limit, reduced?
To what extent have New Zealanders lost their appetite for debt?
And as ever, what shocks will come along from the rest of the world?
Inflation is forecast to peak somewhere between 5 and 6 per cent in the middle of next year.
A majority of the coming spike in inflation is the one-off result of Government policies - the rise in GST, tobacco excise, and the impact of the emissions trading scheme on energy prices.
The Reserve Bank is supposed to "look through" such impacts on the consumers price index, except to the extent that they undermine the confidence of price- and wage-setters that we do indeed live in a low-inflation economy. In other words Bollard can ignore it if the rest of us do.
But it comes at a time when inflation expectations are already under pressure.
It will be the third breach of the bank's 1 to 3 per cent target band in the space of six years. Over the past five years the annual inflation rate has averaged just under 3 per cent.
An environment of weak demand makes it harder for people to pass on higher costs to their customers or employers or tenants. But as the economy warms up it will get easier.
The central judgment the bank has to make in setting interest rates is how much (if any) spare capacity the economy has. It needs to be confident that boosting demand through low interest rates will deliver more output and jobs and not just push up prices because the economy's productive capacity is already at full stretch.
That calculation boils down to how fast the labour force and labour productivity are growing. Departures to Australia are on the rise again, reducing the extent to which net migration boosts the labour supply.
The recession barely dented the participation rate - the proportion of the working age population either employed or actively seeking work.
Employers preferred to cut hours rather than headcount. While output fell 3.4 per cent during the recent recession, employment declined by 2.5 per cent. With average hours worked per week at a low ebb, economists expect most of the pick-up in demand to be met in the first instance by increasing hours rather than the number of people employed.
On the productivity front a key factor will be to what extent businesses put their money where their mouths are and invest in capital equipment.
Businesses in the sentiment surveys keep saying they intend to increase investment, but evidence that they are following through remains scarce. Imports of capital goods remain relatively subdued, despite a high exchange rate, and borrowing by the business sector continues to shrink.
In addition the business-related tax changes in the Budget are unlikely to encourage capital expenditure.
The Treasury expects the base-broadening measures affecting business taxpayers to bring in more than twice as much revenue as the cut to the corporate rate will cost over the next four years.
ANZ puts the economy's longer-term potential growth rate in the 2 to 2.5 per cent range. So does the International Monetary Fund.
"This means inflation pressure could start to emerge much sooner in the recovery process, compared with previous cycles," ANZ said in its quarterly forecasts last week.
But even if it does, how hard the Reserve Bank needs to lean against it through higher rates will depend on how sensitive borrowers have become to interest rates.
On that score the bank ought to find its brakes, when it needs them, in better working order than last time.
A legacy of the doubling of house prices between 2002 and 2007 is that household debt levels are close to their all-time highs, at around 1.5 times disposable income. The fall in interest rates over the last couple of years only brought debt servicing costs as a share of income back to where they had been in 2006, at the time an historic high.
Globally the low risk premiums embedded in interest rates during the last boom are, of course, long gone and unlikely to return. And the Reserve Bank's own regulatory changes relating to bank funding have also widened the spread between the OCR and banks' cost of funds.
All of this, at a time when unemployment is high and wage growth close to decade lows, should dampen households' appetite for debt. It certainly has so far.
The final factor which could reduce the need to raise rates is another external shock, perhaps in sovereign debt markets or in some geopolitical calamity in, say, the Korean peninsula.
The risks are not all one way, however. In particular the bank may be disappointed that the Budget tax changes did not go further in reducing the danger of another investor-led housing boom, of the kind which had such damaging spillover effects in the last decade.
