Friday, March 10, 2006

Brian Fallow: Bollard is getting behind himself

Last year many commentators were saying that the trouble was monetary policy was not working, Alan Bollard said yesterday

"This year," he added, "they may be saying the trouble is it is working."

On the face of it, with the central bank projecting growth to slow to a crawl and inflation to return to its target band in the second half of this year, the extra half a percentage point twist of the monetary screws late last year was unnecessary. Bollard, unsurprisingly, disputes this.

That late-cycle tightening was in response to signs the housing market was getting a second wind. That's a problem when the bank is trying to slow the economy down and there is a close correlation between house price inflation and consumption growth.

The same bogey - fear of reigniting a housing market that is showing signs of cooling - underlies Bollard's remarkably explicit warning to the money markets yesterday not to get ahead of themselves in pricing in the now-inevitable rate cuts.

The bank says that if the more aggressive easing the markets are looking for is plugged into its present reading of the economy, the outcome is inflation starts climbing again next year, requiring tighter monetary policy in response.

The problem with this once-bitten, twice-shy approach is that it increases the chances that, having been too tentative in its tightening phase, the bank will be too slow to ease and then have to do so more aggressively.

That is just the kind of heavy-footed driving that Bollard's mandate, which speaks of avoiding unnecessary instability in interest rates, sought to avoid.

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