Brash hits back at dissent on growth policy

By BRIAN FALLOW

Former Reserve Bank governor Dr Don Brash has hit back at the view that the bank's approach to monetary policy hobbles economic growth.

In a speech to the Auckland Rotary Club yesterday, he specifically targeted the claim that the bank would never allow growth to exceed its estimate for long enough to show that it was wrong.

Brash, soon to be a National Party list candidate, said it was a widespread view in the business community that as soon as the economy got on a bit of a roll, he stepped in and raised interest rates.

Once price stability had been achieved, monetary policy was about trying to ensure that demand grew as fast as the capacity to supply, he said. If demand grew faster than supply for a sustained period, inflation would start to rise.

"One useful safeguard is that if the bank were to make a serious misjudgment about the economy's potential non-inflationary growth rate, it is likely that this would be revealed in the inflation rate and other indicators before too long."

For example, if the bank assumed that the economy could grow only around 2.5 to 3 per cent without generating inflation, it was likely that signs of excess capacity and increased unemployment would emerge. The result was likely to be lower inflation than expected.

But the record of the past 10 years was that inflation turned out rather high in the target range, not low. Inflation exceeded the top of the target range three times, but never fell below the bottom.

The bank devoted a lot of effort to trying to assess the growth potential, Brash said, using an array of sophisticated econometric techniques, and a large number of indicators and surveys, supplemented by visits to businesses.

But the sustainable growth rate was not an unchanging number. It varied to some extent through the business cycle, with the rate of workforce growth, with the nature and volume of new investment and with the impact of new technologies.

"In the mid-1990s the bank thought, perhaps too optimistically, that the economy was capable of growth-without-inflation of around 4 per cent. In the late 1990s, and partly related to the net outflow of people from New Zealand at the time, the bank saw growth of around 2.5 per cent as being more realistic. Now, with stronger net inwards migration, the rate may be nearer 3 per cent."

If the bank's judgment was that the trend growth rate was 3 per cent, that did not mean it would always raise interest rates to stop it from growing faster than that.

"There will be times when growth can be, and should be, faster than the trend rate of growth without any risk to inflation. After a period of slow growth, the economy may well have plenty of spare capacity."

In 1999, after the slowdown of 1997-98, the economy grew by more than 5 per cent and it was not until the end of the year that he had started to raise interest rates.

"The Reserve Bank does nobody any favours, least of all the business community, by waiting too long before starting to tighten policy, with the inevitable consequence that interest rates need to go up more sharply, and stay up for longer, a few months down the track."

Blaming monetary policy for New Zealand's slow growth shifted attention from factors that could increase growth - "the really tough stuff like improving the quality of the education system, ensuring the tax system encourages innovation and risk-taking, reforming the welfare system, reducing barriers which inhibit high-quality investment, opening new markets for our products, and so on."