Front of mind, as the Reserve Bank contemplates risks to its cheerful view of the economic outlook, is the United States.

The bank's latest forecasts see the economy's course set fair for some pretty good outcomes: growth north of 3 per cent, inflation rising only gradually towards 2 per cent, and the unemployment rate trending down, even with historically high labour force participation.

It does not expect to adjust the official cash rate over the next two years at least, and any change is as likely to be down as up.

But the assumptions upon which this forecast is based are, as ever, hostage to events and in particular to developments in the other 99.7 per cent of the world economy.


What happens over the national horizon affects us not only through trade and capital flows, but also through commodity prices, exchange rates and banks' funding costs (so long as we remain so abjectly reliant on importing the savings of foreigners).

Reflecting on the international risks in a speech to a business audience in Auckland today governor Graeme Wheeler touched on uncertainties arising from Europe (Brexit, upcoming elections, Greek debt, vulnerable banks) and China (perilously rapid credit growth, the challenges of economic rebalancing).

But he focused mainly on the downside risk from an increase in trade protectionism in the United States and, just to be fair, upside from potential fiscal expansion there.

The broader context is a world in which growth in trade has been weakening and protectionist measures becoming more common. The World Trade Organisation reckons global trade volumes grew 1.7 per cent last year, much less than world output and the weakest growth since the global financial crisis. And the number of trade-restrictive measures in place around the world rose 17 per cent last year.

Donald Trump evidently has a primitive view of international commerce. He is fixated on bilateral trade balances, ignoring the fact that with the proliferation of border-crossing supply chains, most trade these days consists of intermediate goods, bits of things, rather than finished products.

He shows no sign of grasping that a current account deficit is the mathematically inevitable flipside of net capital inflows.

He has repeatedly called China a currency manipulator that gains an unfair trade advantage by keeping its exchange rate artificially low and has talked of punitive tariffs of 45 per cent on Chinese imports.

That may have been a fair cop in the past. But it is a ludicrous charge to level today, when the People's Bank of China has been spending hundreds of billions of dollars of its reserves trying to prop up the renminbi and tightening its capital controls to the same end.

Key appointments Trump has made - Peter "Death by China" Navarro as chair of a new national trade council and Robert Lighthizer as US Trade Representative - suggest the outbreak of trade hostilities between the two largest economies is only a matter of time.

Trump has also launched a rhetorical fusillade at Mexico and the US firms which have located production there, and signalled an intention to renegotiate the North American Free Trade Agreement.

Donald Trump evidently has a primitive view of international commerce.


Meanwhile, Republicans in Congress are pressing for a corporate tax reform including "border tax adjustments". In redefining the taxable base for corporate income, it would exempt export revenues but deny a deduction for import costs - effectively subsidising exports and taxing imports at the whatever the new, lower corporate tax rate would be. Economists expect such a move to be offset by a higher US dollar.

Wheeler, in a circumspect, central bankerly way, points out that higher tariffs "would raise prices for US consumers, could require an accelerated tightening in monetary policy by the Federal Reserve and could be expected to put upward pressure on the US dollar exchange rate."

Higher US tariffs would invite retaliatory action by other countries, raising prices for consumers and disrupting global supply chains.

"New Zealand would not fare well in such circumstances. Even if our exports of goods and services to the US - currently over $8 billion - were not directly subject to higher tariffs, we would be hard hit by a downturn in the global economy, including among our main trading partners, in response to the direct and indirect impact of protectionist measures. We would experience lower global demand and weaker commodity prices."

New Zealand would also be hit via financial markets as a rise in risk aversion pushed up banks' external funding costs, which have already been rising, especially since Trump's election has seen the US yield curve steepen.

"In such a situation portfolio flows may shift to larger more liquid financial markets and our exchange rate could fall, placing upward pressure on domestic prices and eroding real incomes," said Wheeler.

Offsetting the growth-retardant properties of Trump's trade policy, however, is the prospect of a more expansionary fiscal policy in the United States.

Trump has flagged a desire to cut income taxes (weighted to those on higher incomes) and spend up large on infrastructure and the military, while leaving the big entitlement programmes, Social Security and Medicare, alone.

US fiscal policy, however, is not decided by the President alone. It is the outcome of tortuous and protracted interactions between the two houses of Congress and the White House.

It will be many months before it is clear to what extent the equity markets' enthusiastic greeting to Trump is justified. The devil will be in the detail, along with a host of lesser imps and demons.

On balance, though, it is reasonable for the Reserve Bank to assume there will be a fiscal stimulus in the US which represents upside risk for New Zealand.

Its magnitude remains to be seen, but Wheeler said modelling done within the bank suggested a fiscal expansion which boosted US gross domestic product by 1 per cent would increase New Zealand's GDP by around 0.3 per cent after 18 months, reflecting higher commodity prices and increased trade with US and other countries benefiting from the US stimulus.

It would not be all good news, however. Longer-term interest rates would rise, reflecting an increase in borrowing by US Government, pulling longer term interest rates here higher too, which would flow into higher mortgage rates.