The Economy Hub: Do interest rates matter?

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell

As interest rates drift closer to zero and lose their power to influence markets, it is time for a major focus shift to fiscal policy - or government spending - says Prasanna Gai, Professor of Macroeconomics at the University of Auckland.

"It is time for a paradigm shift in fiscal policy and productivity," he told The Economy Hub video show today.

In the past few months a number of voices locally and globally have argued that this economic cycle of low inflation and low wage growth is creating asset bubbles, exacerbating inequality and driving political instability.

Gai doesn't favour calls for a change in monetary policy target settings to reduce the focus on inflation.

Monetary policy is run by central banks independent of poltical influence, it involves changing the interest rate and influencing the money supply.

Fiscal policy involves the use of levels of government spending and tax settings to influence aggregate demand in the economy.

"The question is: what do we care about? We have inflation down near zero, but that's not necessarily such a bad thing, we have price stability," he said.

"If we care about stimulus and we care about growth that's not something for central banks. It's something for other arms of government - pushing productivity which is particularly low, that's far more pressing if we care about growth and aggregate demand."

Changing a target now would potentially lead to confusion, he said.

Westpac acting chief economist Michael Gordon said he wanted to see a tighter focus on the inflation target, although he wasn't in favour of shifting from the 1 to 3 per cent range, or 2 per cent mid-point.

"Some people say inflation targeting is dead, if that's so then it's been killed with kindness," he said.

"There needs be tighter enforcement of it. The problem at the moment is the only option the Finance Minister or the Reserve Bank board has is the nuclear option of sacking the governor, and of course they don't want to do that, so it's just left to drift."