##calating house prices are presenting a threat to financial stability but not yet to general inflation, macro - prudential policy offers the most appropriate response. bis central bankers ’ speeches 3. the role of macro - prudential policies one of the major insights from the global financial crisis ( gfc ) was how rapidly macro instability could develop even though an economy might be growing close to its potential, and be experiencing sound fiscal policy and price stability. economic and financial risks can build up for several reasons, including over - investment in particular sectors such as housing, a rapid increase in leverage in the banking and shadow banking sectors, and excessive household indebtedness. the output losses and increased human distress from the massive adjustments in the balance sheets of households, corporates, banks, and governments are still being felt in many countries five years after the initial impact of the gfc. the fallout from the gfc triggered a renewed interest in macro - prudential policy in several countries. while micro - prudential policy settings ( e. g., capital ratios and risk weights ) are fixed on a through - the - cycle basis, macro - prudential policy measures provide an overlay to mitigate significant but transitory risks ( such as credit and asset price cycles ) that can endanger the economy and the financial system. in may 2013, the minister of finance and the reserve bank signed a memorandum of understanding outlining the purpose of macro - prudential policy, the range of policy instruments, and governance arrangements relating to their possible deployment. the macro - prudential policy framework seeks to build additional resilience in the domestic financial system during periods of rapid credit growth, rising leverage, or abundant liquidity. the instruments can also help to dampen growth in asset prices that pose risks to financial stability. the macro - prudential measures may require banks to hold additional capital buffers, have higher proportions of stable funding, or limit the share of high loan - to - value ratio ( lvr ) residential lending. instruments such as the counter - cyclical capital buffer and sectoral capital overlays require banks to hold additional capital against potential shocks in asset markets or particular sectors. a temporary increase in the core funding ratio would make banks more resilient to liquidity shocks and, like capital buffers, serve mainly to increase the resilience of bank balance sheets rather than have a significant dampening effect on asset cycles. lvr restrictions have the added benefit of dampening

change cpi contribution food 4. 0 1. 0 petrol 14. 3 0. 5 construction 5. 7 0. 3 household energy 6. 6 0. 2 local authority rates 7. 0 0. 2 total cpi 3. 2 3. 2 source : statistics new zealand, rbnz estimates. figure 1 some contributions to quarterly cpi inflation source : statistics new zealand, rbnz estimates. as the global economy has weakened, commodity prices have fallen again, substantially in some cases. since july, global oil prices have declined by two - thirds and are back to mid2005 levels. other commodity prices have also eased, including prices for our agriculturally based exports, with international dairy prices now around half of where they were a year ago. sharply lower commodity prices are expected to flow through into lower consumer prices. however, the impact on short - term inflation will depend on a number of factors including the exchange rate, other costs, taxes, and firms ’ margins. in the past, these factors have tended to mitigate the impact on retail prices. although global oil prices more than doubled between mid - 2005 and mid - 2008, new zealand retail petrol prices only increased by around 60 percent over the period. retail petrol prices have been dropping recently, but we believe they should be dropping further to restore refinery margins. similarly, retail dairy prices only increased around 25 percent from early 2007 to october this year, while global dairy prices more than doubled to their peak in late 2007. in addition, there was a lag of more than six months before higher global dairy prices flowed through to the retail level. however, now that global prices have crashed, there is plenty of room for retail price cuts. the exchange rate has tended to play a buffering role and has helped moderate the impact of large swings in global commodity prices in new zealand dollar terms. despite the substantial appreciation of the new zealand dollar between 2002 and 2007, tradable cpi inflation has remained quite high. this may partly reflect trends in global import prices, but it is also likely to reflect some importers widening their margins when the nzd was going up and demand conditions were more favourable. while the lower nzd will eventually lead to higher inflation, this will be tempered by lower global import prices and a narrowing in firms ’ margins to reflect the current demand climate. the prevalence of discounting and reports of high retail stocks suggest some temporary respite for retail prices from the lower dollar. as a result of all this, the bank ’ s december