When you keep on missing your goal, maybe the best answer is to try aiming somewhere else.

Should the Reserve Bank's inflation target be lowered, ask the Bank of New Zealand's economists.

The target band of 1 to 3 per cent, "with a focus on keeping future average inflation near the 2 per cent target midpoint", is not, after all, Holy Writ. It was not chiselled into the back of the tablets Moses brought down from Mt Sinai.

The target band has been changed twice already, from its initial 0-2 per cent when Don Brash had the task of dealing to rampant inflation and high inflation expectations, to 0-3 per cent in 1996 and then to 1-3 per cent in 2002, with the explicit focus on the mid-point added when Graeme Wheeler took office in 2012.

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The concern is that if the 2 per cent target - which is the international norm - is too high, too hard to reach in the world we now live in, then central banks will be running monetary policy too loose and storing up trouble in the form of asset price bubbles.

There are a couple of reasons why 2 per cent has become the norm.

One is the belief that if inflation is bad, deflation is worse, a kind of black hole with an imperceptible event horizon around it, crossing which seals your fate. Best to steer well clear.

The other is the problem of the two zeroes. There are times, unhappy times, when real interest rates need to be negative and real wages need to fall.

But it is hard to get people to accept negative nominal interest rates or pay cuts. Having some inflation creates room for real interest rates to decline before the zero lower bound on nominal rates becomes an issue, and for real wages to become more competitive when nominal ones are sticky.

Nobel laureate economist Paul Krugman argues that the 2 per cent target is too low. "What we have learned since [the global financial crisis] is that the zeroes are a much bigger issue than the consensus had it; that you can spend six years and counting at the zero lower bound on interest rates, that you can face many years of grinding, painful adjustment as countries or regions try to achieve 'internal devaluation'."

Meanwhile, recent research by the Bank for International Settlements - the central banks' central bank - suggests that deflation dread may be overdone and it is time to move out from the cold dark shadow of the Great Depression.

They looked at the historical record - episodes of deflation (which they define quite broadly as periods of annual decline in the prices of goods and services) in 38 economies over the past century and a half. There were 663 in all.


In the post-war period deflation episodes have been notably less frequent, shorter and shallower than for the sample as a whole.

They could not find any statistically significant correlation between deflation and weaker economic growth. "Indeed in the post-war era, in which transitory deflations dominate, the growth rate has actually been higher during deflation years at 3.2 per cent versus 2.7 per cent [in inflation years]."

But when they look at asset prices (property and shares) rather than consumer prices, it is a different story. "Asset price deflations, and particularly house price deflations in the postwar era, have been more damaging." They find no support for the idea that higher levels of household debt amplify the negative effects of falling consumer prices, but again it is a different story with property price deflations.

The implication is that prevailing inflation targets exaggerate the risk of deflation and underestimate the risk that the current period in which the word is awash with cheap money will be followed by a grim one when asset bubbles have burst all over us.

Even if the Reserve Bank agreed with this analysis - and there is no evidence it does - it is severely limited in what it could do about it through monetary policy.

We have to live with whatever is happening in the other 99.8 per cent of the world economy and the fact that turnover of New Zealand dollars on global foreign exchange markets runs at about US$100 billion a day. Being small, open, heavily indebted and out of step is an uncomfortable combination.

The bank has raised its official cash rate 100 basis points only to see fixed-term mortgage rates fall, under the weight of declining global interest rates. It has concluded that any further increase is the last thing the economy needs right now.

But does that mean that a rate cut is in order, as financial markets are inclined to think? The BNZ economists say no.

"So what should the Reserve Bank do about the depressed international inflation that is wending its way into the local CPI? See it for what it is, we would say, and indeed the benefits it is delivering to the New Zealand economy, rather than any sign that the domestic economy is faltering and in need of super monetary stimulus," BNZ economist Craig Ebert said.

If the Reserve Bank believes that international inflation is going to persist at historically low rates for a while yet, and that the exchange rate is not going to fall much over the coming years, then why not just lower its CPI inflation target to, say, 1 per cent?

To keep on trying to hit the existing target in this environment, he argues, is tantamount to saying we need to over-stimulate the domestic economy, and its internal inflation, in order to hit a precise CPI inflation number agreed to in different times.

A better response would be to accept the imported deflation while trying to keep the local economy on an even keel, even if that means inflation wobbles around 1 per cent. Use, in short, all the bandwidth, all the flexibility, the existing target band affords.

To be fair, the bank could argue it is doing that. It has signalled that the official cash rate is on hold for as far ahead as it cares to project (two years) though that is, as ever, hostage to events.

Its forecasts have inflation well below 1 per cent all this year and rising only gradually towards - and not to - 2 per cent in 2016. In the end monetary policy is an exercise in archery, not darts. Given the distance, the crosswinds and the fading light, aiming for the bull's eye offers the best chance of landing somewhere on the target.

Inflation hits and misses

• The target: 1-3% annual inflation, with a focus on 2%
• The result: 1.2%, on average, for the past three years
• The forecast: 0.9% on average, for the next two years.