Reserve Bank backs inflation targeting

Speeding up cuts to interest rates would be unsustainable and further inflame an ‘‘already seriously overheating property market,’’ Reserve Bank governor Graeme Wheeler says.

But he says changing the central bank’s inflation targets is not the answer to the challenges it faces, a view shared by Finance Minister Bill English, while also defending his approach to rate cuts.

Wheeler’s speech to the Otago Chamber of Commerce, delivered by assistant governor John McDermott on Tuesday, explained how monetary policy expectations often ran ahead of reality.

This was because the influence of monetary, particularly in small, open economies, was ‘‘heavily constrained’’ by global economic and financial factors.

Wheeler said the Reserve Bank still expected a further 35 basis points to be cut from interest rates, and dismissed claims it should either hold the rate at its all time low, or rapidly reduce it.

There was a view rapidly lowering rates would bring inflation back within the policy targets agreement of between 1 per cent and 3 per cent, but Wheeler said this would ‘‘not be regarded as sustainable.’’

‘‘Rapid and ongoing decreases in interest rates would likely result in an unsustainable surge in growth, capacity bottlenecks, and further inflame an already seriously overheating property market,’’ he said.

‘‘It would use up much of the bank’s capacity to respond to the likely boom/bust situation that would follow and would place the Reserve Bank in a situation similar to many other central banks of having limited room to respond to future economic or financial shocks.’’

Wheeler said the inflation target was still the most appropriate framework and the bank was ‘‘committed’’ to achieving the inflation goals.

English said there was a regular cycle of looking at the policy targets agreement every five years or when a new government came to office and that was ‘‘appropriate’’.

He said details of the regime were open to discussion both of the range that is to be targeted or how decision making was structured within the Reserve Bank. ‘‘But as a general principle we support inflation targeting and what you see happening around the world is Reserve Banks certainly not giving away inflation targeting – in fact going to extremes to try and achieve inflation targets.

He said it was a misunderstanding that because inflation targeting was difficult and there was extraordinary monetary policy all over the developed world ‘‘that somehow inflation targeting is no longer relevant – it’s certainly relevant’’.

Asked if he would be comfortable with official interest rates at zero, he said it was the central bank’s job to make that decision.

Labour Finance spokesman Grant Robertson said Wheeler’s speech showed current monetary policy needed to be reviewed, with changes to the policy targets agreement a bare minimum.

The Reserve Bank Act was nearly 30 years old and the world had changed ‘‘hugely’’ since then, he said.