Column: Decision to drop rates no longer knife edge stuff

Last week's decision by the Reserve Bank to drop interest rates no longer looks as knife-edge as it did at the time.

Reserve Bank governor Don Brash described the decision as "finely balanced when he cut the official cash rate to 0.25%, and the cut certainly caught most of the bank and market economists by surprise.

The general expectation was that the governor would issue a warning but leave rates where they were.
Under questioning from MPs Dr Brash conceded that the central bank had been going to do just that, but a wave of more economic bad news from Japan had forced a hurried reconsideration.

The decision was so eleventh hour that the bank's Monetary Policy Statement booklet opening page - which contains Dr Brash's speech - had to be yanked off. So economists had the slightly odd situation of a speech announcing a rate cut, accompanied by a booklet of data written as though rates were being left alone.

The cynical view, and there are no shortage of cynics when it comes to the operation of monetary policy, was that Dr Brash was a tad jumpy following the release of the Lars Svenssen report on monetary policy only a fortnight earlier.

The Svenssen report which actually concluded that New Zealand monetary policy usually runs pretty well and was also highly laudatory of Dr Brash's skills, did nonetheless find that the central bank got it wrong a couple of times over the decade.

Most significantly, it suggested that the decision to hold up interest rates for too long at the start of the Asian crisis had hurt New Zealand¹s economy.

The cynical view last week was that Dr Brash was not going to get caught like that again, and that a small, 0.25% cut would not cause too much of a stimulus. The move was, in more ways than one, precautionary.

Further blasts of bad economic news from Japan and the US over the past week, plus US Federal Reserve chairman Alan Greenspan's decision yesterday to cut US rates by 0.5%, seem to have validated the New Zealand central bank's position.

It appears also to have been endorsed by the markets, which have factored in another New Zealand rate cut in either April or May, despite Dr Brash's repeated warnings on Wednesday that the drop did not necessarily presage further cuts this year.

More than one US analyst expects Greenspan to drop US interest rates again by May, as job growth in that country is expected to skid to a halt and consumer confidence is looking decidedly peaky.

For New Zealand, Macquarie Bank economists pointed out this week that whether the New Zealand economy holds up will largely depend on how far the US downturn affects the Asian markets. Overall growth in the region is still expected to be about 5% over 2001, and if this holds up, New Zealand could weather the storm without a recession.

While the Treasury earlier this week released advice to the government suggesting a lower rate of growth over this year than was expected in the December Economic and Fiscal Update, its analyses is not shared by most market and bank economists ­ or their minister.

If they are right, and the Treasury is wrong, it does however seem to suggest that Dr Brash will leave interest rates as they are.

ANZ Bank chief economist Bernard Hodgetts pointed out this week that the New Zealand economy is running near to full capacity, and that wages and prices look set to rise without much in the way of productivity gains.

If that transpires, the resulting inflation is going to give Dr Brash very little room to provide further interest rate relief ­ despite what Greenspan might be doing in the United States.

Rob Hosking is a Wellington-based freelance writer specialising in political, economic and IT related issues.

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