New PTA won't help pick up sustainable growth - report

By NZPA

Tuesday 1st October 2002

A group of Reserve Bank economists have poured cold water on the notion that the new, looser Policy Targets Agreement (PTA) will mean New Zealand is better placed to achieve sustainable economic growth.

New Reserve Bank governor Alan Bollard and Finance Minister Michael Cullen signed an agreement last month giving the central bank more leeway in meeting a narrower inflation target.

The five-year agreement raises the bottom limit of the target to a 1-3 percent band, rather than 0-3 percent, and allows the bank to meet that target "on average over the medium term".

But a new report by economists Anne-Marie Brook, Ozer Karagedikli and Dean Scrimgeour, found "little compelling evidence" to suggest that slightly higher or lower average rates of inflation would lead to significant change for sustainable economic growth in New Zealand.

At low rates of inflation -- below 3 percent -- the report found no correlation between inflation and growth.

"Most economists have concluded that it would be difficult to distinguish between alternative average inflation rates in the range of around 1 to 3 percent," the report, published in the Reserve Bank's September Bulletin, said.

"One percent is typically chosen as a lower bound in the inflation target range, not because there is robust evidence to suggest that average inflation rates between 0 and 1 percent are detrimental to growth, but rather for political economy reasons, and in recognition of the increased risks of persistent deflation when inflation is very low."

The report echoes comments by private sector economists last month that the agreement will effectively mean little change.

"It's a change for change's sake," WestpacTrust chief economist Adrian Orr said after the new PTA was penned.

"The economic rationale is not clear. There is no evidence that allowing a little more inflation is useful."

The Bulletin report also found that any "optimal" rate of inflation, if one exists, would vary across countries and over time, depending on broader economic policy and institutional frameworks.

If inflation had only "sand", or negative, effects on the economy -- getting in the way of the smooth turning of the wheels -- then the optimal rate of inflation would be zero.

Inflation could be positive, however, serving not as sand but as grease in the mechanism -- allowing more efficient adjustment to economic shocks and meaning the optimal rate would be above zero, the report said.

Economists expect the average core inflation rate to rise to 2.25-2.5 percent under the new PTA, from 2 percent previously.

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