KEY POINTS:
Many of the challenges the Reserve Bank faces in fighting inflation can be linked to the growing role of China and other emerging economies, Governor Alan Bollard says.
Bollard used his annual speech to the Canterbury Employers Chamber of Commerce yesterday to reflect on some of the economic shocks he has had to contend with.
By implication it was an explanation of why inflation has been so close to the top of his 1 to 3 per cent target band, averaging 2.9 per cent over the past three years.
In addition to the emergence of new economic powers, the other big change had been that globalisation had increased the speed and strength with which international shocks hit the New Zealand economy, Bollard said.
The country is enjoying its longest (but not strongest) expansion since World War II, accompanied by low inflation which has averaged 2.2 per cent over the past 10 years.
But the reduced volatility in both prices and growth should not be taken for granted.
"New Zealand knows only too well what happens when the 'golden weather' comes to an abrupt end as it did in the early 1970s," he said.
Back then an economic boom driven by favourable terms of trade came to a halt when export prices collapsed and the first oil shock hit.
"As a consequence New Zealand entered a prolonged period of high inflation and low growth which eventually precipitated a painful but necessary period of major economic restructuring."
The challenges the Reserve Bank faced today sprang in part from the growing importance of China, India and other rapidly industrialising countries in the world economy, Bollard said.
Their demand for fuel has seen oil hit US$100 a barrel this month, $80 higher than at the start of 2002. Higher oil prices had added 0.5 percentage points a year to inflation since 2004.
The broader commodity boom has meant that on a net basis New Zealand was significantly better off, with the most favourable terms of trade since the early 1970s. That comes at a price in terms of inflationary pressure, however.
Bollard said the recent run-up in food prices would add about 0.4 percentage points to the consumers price index over the next year, and the indirect inflationary effects from higher incomes were likely to be at least three times the direct effects.
The emerging economies were also implicated in what at first glance might seem purely domestic shocks such as the rundown in household savings and housing boom, he said.
By recycling their trade surpluses by buying US dollar assets they had helped keep US and global interest rates low, contributing to the easy credit conditions prevailing for much of the past five years.
One consequence has been that it has taken longer for the Reserve Bank's rate hikes to work in reducing housing-related inflation pressures, because banks could borrow cheaply offshore.
Lower interest rates had enabled households to service a higher level of debt, which when combined with easier credit and a generally buoyant job market had seen the household saving rate turn strongly negative since 2002, Bollard said.
"Monetary policy has had to deal with the inflation consequences of debt-financed consumption spending over the past decade. Reserve Bank calculations suggest the increase in personal consumption could have contributed 0.5 to 1 percentage points per annum to annual inflation from 2003."
The emerging economies are also a factor in a new price shock the bank has to think about - carbon pricing.
While acknowledging that much of the damage to the climate came from the accumulated stock of greenhouse gas emissions mainly from the advanced economies already in the atmosphere, it was the emerging economies which would contribute most to emissions in the future, Bollard said.
The Government's principal policy to combat climate change is an emissions trading scheme which will raise petrol and diesel prices from the start of next year and electricity prices from 2010.
The bank estimates these measures will add 0.25 percentage points to inflation next year and 0.35 in 2010.
Big bangs
Shocks the Reserve Bank has had to contend with:
* Surging oil prices
* Booming commodity prices generally
* A housing boom
* A rundown in household saving
* Moves to mitigate climate change
