Cullen's inflation barb draws bites from both sides

By BRIAN FALLOW economics editor

Finance Minister Michael Cullen turned up the volume in his criticism of the Reserve Bank yesterday, saying its interpretation of its inflation target clearly differed from the Government's.

The Reserve Bank Act requires the bank to run monetary policy so as to maintain stability in the general level of prices, without specifying what constitutes price stability.

That is defined in the policy targets agreement, which is negotiated between the Minister of Finance and the Governor. Since 1996 the target has been to keep annual increases in the consumers price index at between 0 and 3 per cent. At a briefing on the release of the Treasury's pre-election economic and fiscal update (Prefu) yesterday, Cullen said Acting Governor Rod Carr's recent responses to Parliament's finance and expenditure committee showed the bank believed it had a point target of 1.5 per cent.

That was not the Government's interpretation of the target, Cullen said.

The Government's interpretation was that it was a range of 0 to 3 per cent and if necessary the agreement would be amended to clarify that.

He was not talking about widening the target band or saying that there should be more tolerance of breaches of the 3 per cent level.

Nor was he saying that the bank had tightened monetary policy unnecessarily. "I am not entitled to comment on individual decisions of the Reserve Bank. But I am perfectly entitled to comment on their interpretation of a contract I am party to."

However, he echoed thinly veiled criticism he has already made of the hawkish monetary policy statement the bank published on May 15, after which the kiwi dollar's appreciation steepened.

It was an "'interesting question" why the New Zealand dollar had risen against the United States dollar faster than the Australian dollar had. "Most financial commentators ascribe that to interest rate differentials," Cullen said.

Former governor and National parliamentary candidate Don Brash said: "It is a delusion to suggest that we can crank up growth sustainably by tolerating more inflation and that is what he seems to be implying.

"If he is implying that policy has been run too tightly and that has been inhibiting growth in the economy, the reality is inflation outcomes have been almost always in the top half of the inflation range, and over the past decade have breached the top of the target range on three occasions. So it is hard to argue we have been consistently too tight."

Since the target was widened to 0 to 3 per cent, inflation has averaged 2 per cent.

Council of Trade Unions economist Peter Conway welcomed Cullen's comments. "We have been concerned for some time that instead of aiming to keep inflation below 3 per cent, the Reserve Bank is trying to drive inflation down to 1.5 per cent and damaging the tradables sector in the process."

The Bank of New Zealand's head of market economics, Stephen Toplis, described Cullen's comments as grandstanding and an exercise in pedantry.

"Why would any central bank not aim for the mid-point of a specified target band as it attempts to keep as far away as possible from breaching its requirements?"

If Cullen convinced investors he would successfully beat up the bank it could be an own goal, Toplis said.

"In the longer term the currency will go where it is going to go no matter what any Finance Minister says. But if investors perceive that the minister is going to meddle in the monetary policy-setting process and/or encourage higher inflation, then interest rates - particularly at the longer end of the curve - are likely to be higher than would otherwise be the case."

Deutsche Bank economist Darren Gibbs said that if the policy target were amended it might be in the direction of the Reserve Bank of Australia's by requiring the bank to achieve 0-3 per cent "over the economic cycle" rather than at all times, thereby adding more flexibility.

As expected the Prefu, coming only a month after the Budget, contained little change to the economic outlook.

The only significant change is that, with the dollar having risen 6 per cent on a trade-weighted basis since the Budget forecasts were finalised, monetary conditions have tightened earlier than it forecast.

The Treasury has accordingly reduced its growth forecast for 2003/04 from 3 to 2.7 per cent, but that lost output is largely recovered the following year.

Some factors supporting the dollar's rise would be unwound, the Treasury said, as interest rate differentials narrowed and the current account deficit widened.