performance, or strong forces such as commodity price swings or domestic demand pressures, can generate substantial and prolonged departures of the exchange rate from its long - run average levels. a second key judgement in our forecasts is the extent to which household spending is constrained by high debt levels and the gfc experience, which has implications for the degree to which the strengthening housing market will feed into private consumption. finally, the profile and wider spillover effects into construction costs of the canterbury rebuild will depend upon how capacity pressures are resolved. our current judgements are that the household debt position means consumption is likely to follow less of a pronounced upswing as a result of the housing market upturn than has historically been the case, and that the concentrated character of the rebuild means its spillover effects to housing markets in the rest of the country will be muted. however, since there is little recent experience against which to benchmark these events, we will have to monitor the evidence carefully to ensure that our judgements in this area remain reasonable. the current environment also confronts us with trade - offs across policy objectives. near - term inflation is low and is forecast to gradually increase back to the midpoint of the target range. an interest rate cut might help inflation return to target sooner. but such a cut would also probably exacerbate the current strength in house prices, risking further increases in private debt levels, potentially raising financial stability issues. indeed, the pta specifies that, in setting monetary policy, we must monitor asset prices and have regard to the soundness and efficiency of the financial system. 3 on the other hand, while an interest rate hike might limit housing market risks, it could also place further upward pressure on the exchange rate. in the near future, macro - prudential measures will be part of the toolkit for responding to financial stability risks. these measures will generally support and complement our efforts to stabilise inflation with monetary policy, as upswings in the macroeconomy often coincide with increasing asset prices and leverage. we ’ re currently engaged in consultation regarding the use of macro - prudential instruments and will say more about this in our upcoming financial stability report. a box in the december 2012 monetary policy statement explains the new pta. bis central bankers ’ speeches 4. forecasting supports accountability and communication activities forecasts, risk assessment and management of trade - offs are a critical element of our communication of policy strategy and accountability for our actions. we aim to be as clear as

policy for banks which is intended to make the system less vulnerable to a drying up of international funding markets, such as we saw in late 2008 and early 2009. can prudential instruments such as minimum capital and liquidity requirements also help monetary policy? this depends on the link between those instruments and bank funding and lending, and also between bank lending and the behaviour of housing and other asset prices. in the case of housing, the link between mortgage lending and market prices is fairly clear. what is less clear is the extent to which the instruments themselves may constrain bank lending and housing demand in an emerging boom. at this stage, we believe that the new liquidity policy and in particular the core funding ratio could usefully contribute to the monetary policy task by limiting the banks ’ ability to fuel credit growth using cheap and plentiful short - term wholesale funding during boom periods, as was the case from 2003 to 2007. in this respect, the core funding ratio could potentially act as an automatic stabiliser and reduce the required hikes in the ocr during economic upturns. the role for a macro - oriented minimum capital requirement in promoting macro - financial stability ( as opposed to individual bank resilience ), and also assisting monetary policy, is less clear. the relationship between capital requirements and loan pricing is highly uncertain, particularly as the large lenders in new zealand ( as elsewhere ) target capital holdings well in excess of current regulatory minima. at best, these instruments could supplement the role of the ocr, but will not fundamentally alter it. ideally, they would change the mix of monetary conditions and take some pressure off the exchange rate. overall monetary conditions would still need to be set appropriately to keep inflation stable. we must also be realistic about the learning that still needs to be done in the macro - financial area. central banks do not yet understand enough about the properties of prudential instruments to use them as an adjustable policy lever, and doing so could raise coordination issues between monetary policy and prudential policy decisions. more broadly, economists have a relatively good understanding of inflation and the real economy, but the unknowns are much greater when we try to model macro - financial variables. we still have much to learn about how price stability and financial stability outcomes move together, about the relationship of cpi and asset price inflation, and about the interplay of credit and economic activity. as a small, flexible and full - service central bank, the reserve bank is in a good position