Big test still looms for Reserve Bank Governor

By BRIAN FALLOW

The changes at the Reserve Bank since Dr Alan Bollard became governor have been quite profound, says HSBC chief economist Dr John Edwards, but his big test will come later this year.

HSBC was among the advocates of a more liberal policy targets agreement of the kind which was adopted when Bollard took the bank's helm: a higher mid-point for the inflation target range and an explicitly medium-term policy horizon, implying a greater tolerance of error.

"Also there has been more recognition that economic growth is important and that the Reserve Bank shares a responsibility for it," Edwards said told the Herald.

Bollard's conduct of monetary policy so far has lived up to that. "He started tightening in this cycle later than we thought he would and later than the Reserve Bank of Australia did. I do think he is demonstrating more patience."

Edwards expects him to deliver one or two more quarter-turns of the screw over the two or three months.

"The big test for Bollard is what to do then."

The problem is that the strong growth in employment over the past three years has been largely matched by growth in the labour force. The latter reflects not only immigration but a "huge increase" in female participation in the workforce.

"We expect that to flatten out, as it has in Australia, and we also know immigration is slowing."

With labour productivity growth rates evidently still stuck around 1 per cent, the risk is that weaker growth in the labour force will require the Reserve Bank to scale back correspondingly its estimate of the amount of economic growth New Zealand can handle.

"If the economy remains as strong as we think, some time in the second half of the year Bollard will have to decide whether he deliberately slows the economy to meet a constraint he thinks will emerge over the following year, or lets it run as [RBA governor Ian] Macfarlane and [Federal Reserve chairman Alan] Greenspan have done, in the hope that as labour shortages develop employers will become more clever about how they do things."

But won't growth slow anyway because of the high dollar?

"The troubling thing about that argument is that because global growth is so favourable to New Zealand it is not at all evident that exports are turning down ," Edwards said.

"It's increasingly evident the global economy is going to be kind to New Zealand, despite the setback of currency appreciation. The US should continue to grow at around 4 per cent through this year, Japan is enjoying extraordinarily good growth, China too, and they are taking most of East Asia with them. Europe is looking to grow markedly more strongly this year than last year, and Australia - your biggest market - is likely to grow twice as fast in the year to June as it did in the year to June last year."