Watch the revs, MPs told

By Brian Fallow

WELLINGTON - The Reserve Bank cannot turn a four-cylinder economy into an eight-cylinder one, governor Dr Don Brash said yesterday.

Appearing before Parliament's finance and expenditure select committee, Dr Brash responded to the accusation that by moving to raise interest rates before the end of the year - which he said last week was likely - he would prevent the economy from getting up a worthwhile head of steam.

"Even after the tightening we are envisaging, monetary conditions will still be very stimulatory," he said.

"We are still on the easy side of neutral, even after we adjust conditions, if we do, late this year. Over the last 12 months conditions have been very stimulatory. We are talking about easing off on the accelerator a bit rather than hitting the brakes."

Dr Brash said the fundamental growth rate which the economy was capable of had almost nothing to do with monetary policy.

"We can contribute to the sustainable growth rate by ensuring the price system works well, which means by keeping inflation low. But we cannot turn a 2 per cent growth economy or a 3 per cent growth economy into a 7 per cent growth economy by running easier monetary policy."

That was now as widely agreed as any proposition in economics, he said.

"We can ensure the four-cylinder engine runs to its maximum capacity without overheating. We can't convert it to an eight-cylinder engine."

Nor could monetary policy "fix" the current account deficit, Dr Brash said.

"If we ease and the exchange rate comes down, that encourages exports but it also stimulates the domestic economy and sucks in imports."

If on the other hand the bank tightened, that would slow the domestic economy and demand for imports, but it would slow exports as well.

Asked about forecasts that home mortgage rates would peak at about 9 per cent in a couple of years' time, Dr Brash said: "It is precisely because we have got lower inflation and lower inflationary expectations that people can envisage the next interest rate cycle peaking lower than the last one, which in turn was lower than the one before that.

"In the mid-1980s first-mortgage rates were at 21 or 22 per cent. I think 11.25 was the peak mortgage rate in the last cycle.

"It is quite on the cards, if we can keep inflation expectations better anchored, we won't have to go back to those rates again. And that's what the object of the game is."