Opponents give inflation extra squeeze

By BRIAN FALLOW

Michael Cullen and Don Brash continued to trade rhetorical blows yesterday.

The Finance Minister said that trying to "squeeze the last tiny bit" of inflation out of the economy was bad for growth, and the former Reserve Bank Governor said it was dangerous and wrong to imply that you could buy more growth by tolerating higher inflation.

Brash said that if the mid-point of the bank's target range was raised to 2.5 per cent inflation would more frequently exceed 3 per cent. That would dissipate hard-won confidence in low inflation.

"Telling savers the purchasing power of their savings is at risk is a way of pushing up interest rates, not pushing them down," he said.

Cullen said it was not surprising Business New Zealand, the Northern Employers and Manufacturers Association, the Export Institute and others thought the bank was "too obsessed with squeezing out the last small portion of inflation" and was not growth-friendly.

HSBC economist Grant Fitzner said that, since New Zealand has volatile terms of trade, adopting one of the toughest inflation targets going inevitably meant the Reserve Bank had the most aggressive approach to monetary policy in the OECD.

The terms of trade measure the quantity of imports that can be funded by a fixed quantity of a country's exports.

Fitzner said a lot of research indicated that, while inflation above 10 per cent, say, was detrimental to an economy, once that had been eliminated whether inflation was 1 or 2 or 3 per cent made little difference to other outcomes such as gross domestic product per capita.

"Our criticism has always been that the inflation target is too low for an economy with such volatile terms of trade." Australia also has volatile terms of trade but its higher inflation target, with a mid point of 2.5 per cent, had helped it weather the Asian crisis more easily than New Zealand.

Since then the policy targets agreement has been reworded to enjoin the Reserve Bank, in meeting its 0 - 3 per cent inflation target, to avoid unnecessary instability in output, interest rates and the exchange rate.

Market economists generally agree that the bank has run policy more flexibly since then, citing its willingness early last year to cut interest rates even though inflation was sitting at 4 per cent, and the promptness of its "insurance" rate cuts after September 11.

HSBC says that for 10 years inflation has averaged 2 per cent on both sides of the Tasman (excluding a blip when Australia introduced GST), but that Australia has enjoyed a higher average GDP growth rate and lower real interest rates. It attributes the difference in large part to a more trigger-happy NZ central bank, flowing from its tougher inflation target.

But Brash said the RBNZ had been operating a flexible monetary policy little different from Australia's. "The fact that Australia has had around 4 per cent growth over the past decade and we have had less than 3 per cent has got nothing to do with different inflation rates."

It was too easy to scapegoat the central bank, he said. The reasons for our under-performance were more fundamental and more challenging.

Cullen said his criticism of the bank was not an attempt to influence its interest rates decision next week. It would make its own decision, as always.

But National bank chief economist John McDermott said if the Reserve Bank did not raise rates it would look as if it was caving in to the minister. If it did, in the face of the stronger dollar, exporters would complain.