War of words on whether tax cuts would endanger inflation goals

Prime Minister Helen Clark says National will have to borrow to pay for tax cuts and that will push up mortgage rates.

Businesses would also face higher interest rates and the exchange rate would be kept higher than it would otherwise be, she said on Monday when announcing the election date, September 17.

But National's leader Don Brash says he did not spend 14 years as Reserve Bank governor getting inflation and interest rates down to put that at risk through irresponsible tax cuts. "What they are saying is that if they spend your money it isn't inflationary, but if you spend it or save it it is inflationary. This is self-evident nonsense," he said.

The only man whose views on this really count, current governor Alan Bollard, is keeping his own counsel.

When he appeared before Parliament's finance and expenditure committee last month, MPs pushed him on the question of whether tax cuts would be inflationary and trigger a rise in interest rates.

His answer, in brief, was that it would depend. It would depend on what the package did to the balance of supply and demand in the economy.

Anything that added significantly to demand at a time when there were bottlenecks in the economy and the providers of goods and services were struggling to meet existing demand would have inflationary effects.

"I would want to know what the totality of the package was."

It would depend a lot on the timing, on how it was financed (by borrowing or by forgoing Government spending) and on how much of their tax cuts people spent, he said.

At his six-weekly review of interest rates yesterday Dr Bollard was talking tough. He expects inflation to exceed 3 per cent, the top of his target band, even though the economy has been slowing for about a year.

Economists say that the impact of a tax cut package would depend in part on whose taxes were cut, and by how much.

People in higher tax brackets would be more inclined to save some of their tax cuts than those on lower incomes.

A company tax cut which was used to boost investment in productive capacity would be positive from an inflation standpoint; if it just boosted shareholders' incomes and spending it would not be.

Fiscal policy - the net effect of the Government's tax and spending plans - is expected to boost demand in the economy over the next two or three years, in contrast to the past year when tax was pouring into the Government's coffers faster than it was going out.

That is already factored into the Reserve Bank's calculations.

Westpac chief economist Brendan O'Donovan said it was specious to attach the label inflationary to tax cuts but not to increased Government spending. The same ruler should be run over both.