KEY POINTS:
It is the hoon economy.
Like young guys with too much testosterone and no memory to speak of, households are taking a lot of risks.
They feel invulnerable and are happy, year after year, to spend more than they earn and drive up house prices far faster than the incomes out of which mortgages and rents have to be paid.
Household debt has soared since the early 1990s. Measured against average household disposable (after-tax) income, it has climbed from 60 per cent in 1991 to 180 per cent now.
Since 1991 debt has increased at a compound rate of 11.7 per cent a year, while incomes have risen by 3.8 per cent a year.
House values have risen as well, of course, but not as fast as the debt secured against them, increasing the gearing ratio from 17 per cent in 1991 to 25 per cent today, figures from Westpac economists Brendan O'Donovan and Doug Steel show.
And the share of average disposable income needed to service that ballooning debt has climbed steeply, from a 5 to 6 per cent range though the 1990s to 13 per cent now.
What has driven this rise in debt-to-income ratio, ultimately, is the shift to a low-inflation environment.
Lower inflation means slower wage growth, which means a given amount of debt is not eroded as quickly as multiple of income.
Likewise lower inflation means lower interest rates, which means people can service a larger debt from the same income.
And lower inflation is good for growth, and so can take some of the credit for a fall in unemployment from 11 per cent in the early 1990s to below 4 per cent now. The sense of job security adds to households' willingness to take on debt.
The Westpac economists conclude that the rapid increase in debt, and the housing boom it has fuelled, is not to be feared. Most of it has occurred as a result of good macroeconomic policy and may have nearly run its course.
Reserve Bank Governor Alan Bollard takes a less sanguine view.
In a series of speeches, he has pointed out that these household sector-wide averages mask very high levels of debt in a minority of households. Only one household in three has a mortgage, and at any time many of them are well on the way to being paid off.
Borrowers need to be conscious of the risk both of lower incomes - through losing a job, for instance - and of higher interest rates, he says.
The first risk may just have gone up, if the perturbations in world equity markets herald a global economic shock. And if it hasn't, the risk of higher interest rates is high.
The financial markets see only a one-in-five chance that Bollard will not hike the official cash rate next Thursday, even though:
* The most recent readings on economic growth are only 0.3 per cent for the quarter and 1.4 per cent for the year.
* Inflation at 2.6 per cent is inside the target band and heading lower.
* The official cash rate is already 7.25 per cent and has been for more than a year.
* The dollar is close to US70c.
If that is not enough to keep the lid on inflation, what is?
Unhappily, that is not a rhetorical question.
The fall in inflation is a short-term reflection of lower world oil prices; the underlying inflation pressures remain strong.
And those growth numbers relate to the September quarter last year.
The evidence since then is that the economy is gathering speed again - at least the parts which are related to domestic spending rather than export earnings.
There is little sign of the slowdown in the housing market and consumer spending that Bollard has said he needs to see.
But exporters, meanwhile, have to shuffle along as best they can, hobbled by an overvalued currency. And businesses feel the impact of higher interest rates even if the mortgage belt does not.
Therein lies Bollard's dilemma.
Hence the consideration given to misbegotten ideas like giving him two interest rate levers: one for the wider economy and another just for the one-third of households which have mortgages.
Bank of New Zealand economist Stephen Toplis argues that the key in getting monetary policy to work is puncturing that sentiment of being bulletproof.
"Not to put too fine a point on it, the average punter needs to be scared witless. People need to believe the Reserve Bank is on a mission, ie, that it intends raising rates until such time as it gets a response. If that means 100 basis points or more, so be it."
No more Dr Nice Guy. No more giving growth a go. A short, sharp shock.
Or as a Victorian nanny might have put it: "Don't care was made to care."
But what about exporters, and firms which have to compete with imports? Wouldn't they continue to bear the brunt?
In the first instance, yes, says Toplis. But this is one of those cases where things have to get worse before they get better.
"The only way that investors will finally ditch the new Zealand dollar is when they are convinced the economy is softening, the Reserve Bank has stopped tightening and the general risks of investing in the country are rising."
It is a myth, Toplis says, that rising interest rates always result in a stronger currency.
"There is an element of truth in this. Higher interest rates do tend to coincide with a rising currency and this does disproportionately impact the export sector. However, we would contend that the main reason the currency has been as strong as it has over the past year is that interest rates have simply not been high enough."
There are many instances of exchange rates moving quite independently of interest rates and interest rate differentials.
"Even now with the currency around US70c, our interest rate differential with the United States is much lower than when the currency was last there back in 2004/05. When the interest rate differential was last at these levels, the New Zealand dollar was buying US40c."
ANZ National Bank chief economist Cameron Bagrie warns us to get used to a higher dollar on average.
Since the official cash rate was introduced eight years ago, economic growth has been less of a roller-coaster ride. Indeed minimising variability in the growth rate is a (secondary) part of the Reserve Bank's mandate.
Just as less earnings volatility means a higher price/earnings multiple for a company, the same applies for an economy and currency, Bagrie says.
In addition, what looks like a structural shift in the terms of trade - the relative value of the kinds of things we export and import - suggests fair value for the new Zealand dollar is now closer to US65c than the historical long-run average of US58c.
In such a context, US70c is not so extreme.
