New Zealand's economy has grown faster than comparable economies overseas over the last two years, and achieving price stability will help ensure that this expansion is sustainable, Reserve Bank Governor Graeme Wheeler said today.
In a speech to the Canterbury Employers' Chamber of Commerce in Christchurch, Mr Wheeler said that New Zealand's economy has grown at twice the average rate of the 35 advanced economies in the IMF's classification over the past two years.
"Most of our economic indicators are positive; with the terms of trade at a 40-year high, business confidence is the strongest since 1993, and consumer confidence is at a seven-year peak," Mr Wheeler said. "Growth has been driven by expansionary monetary policy; high export prices for our major commodities; strong construction investment, particularly in Canterbury; and the increase in private consumption," Mr Wheeler said.
"The high exchange rate has been a headwind. The Bank would like to see a lower exchange rate and does not believe the exchange rate is sustainable in the long run."
He said that the Reserve Bank wants to see sustained expansion in the economy, and that inflation is an important risk to ongoing expansion.
"Some increase in inflation pressure is inevitable. Inflation pressures are increasing in the construction sector in particular, as resources are reallocated to Canterbury and Auckland from other regions and activities, and spare capacity in the economy is being absorbed at a rapid rate," he said.
"Stronger inflation pressures and the increase in interest rates that would accompany them could put pressure on New Zealand's real effective exchange rate and reduce the competitiveness of our export and import substitution industries," he said.
"The Reserve Bank's goal under the policy targets agreement is to keep future average inflation near the 2 percent target midpoint. Achieving this will help to ensure that economic activity is kept more in line with the potential growth of the economy, thereby promoting a more sustainable expansion."
A further risk to economic expansion is the level of house prices. "The risks that the housing market pose to financial stability and the broader economy were a major reason for introducing speed limits on high loan-to-value ratios for residential mortgages last year," Mr Wheeler said.
"We have supported the recovery through low policy rates. We recognise that the economy has been growing faster than potential output growth for some time. Although headline inflation has been moderate, inflationary pressures are building and are expected to increase over the next two years. In such an environment, there is a need to return interest rates to more normal levels, and the Bank expects to begin this adjustment soon.
"Achieving this will help to ensure economic activity is kept more in line with the potential growth of the economy, thereby promoting a more sustainable expansion," Mr Wheeler said.
View the speech: The building blocks of the economic expansion
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