Bob Edlin’s comments (The Independent, 21 May 2003) on my behaviour as Governor of the Reserve Bank can’t go unchallenged.
He asserted that I believe this economy’s long-term growth rate is still 2%–3% (and that’s true), and that, because I held that view as Governor, “whenever it looked like the economy might build a 4% head of steam, [I] would fret about over-heating and inflation and cool things down by hoisting the official cash rate. The effect was to keep GDP growth at 2%–3%.”
The clear implication is that, if only I had been willing to believe that the economy was capable of 4% growth, hey presto, that could have been accomplished. Several comments.
First, in the 10 years to the end of last year – which coincides closely with the period since the 0–2% inflation target was first achieved in 1991 – economic growth averaged 3½%, and exceeded 4% on at least three occasions, hardly suggestive that I was committed to braking the economy at the first sign of growth.
Second, and more important, it isn’t monetary policy which ultimately determines a country’s rate of economic growth. If a central banker underestimates how fast an economy can grow – runs monetary policy on the assumption that its maximum growth is, say, 2% when it is actually capable of growing at 4% – the outcome will be falling inflation and ultimately deflation. That’s because the central banker is constraining demand growth at below the economy’s capacity to supply.
Conversely, if he assumes the economy can grow at 4% and runs monetary policy accordingly when actual potential growth is only 2%, inflation starts rising and keeps rising until the central banker realises he’s got it wrong.
And was I too pessimistic about the economy’s potential growth rate in the nineties? If I had been, inflation outcomes would have tended to be towards the bottom of, or below, the inflation target. In fact, actual inflation outcomes were consistently in the top half of the inflation target, breached the top of the target on three occasions and never looked like breaching the bottom.
I badly wanted to believe that the New Zealand economy was capable of 4% trend growth, but it wasn’t capable of 4% growth in the nineties and it certainly isn’t now. Indeed, the Treasury projects GDP growth to average just 2½% over the next 10 years.
The main reason I left the Reserve Bank to enter politics is that I want to increase our trend growth rate above 2½% – and that involves good monetary policy to be sure, but mainly involves better policies on taxation, education, infrastructure and much more.
Copyright © 2024 Don Brash.