alan bollard : everyone needs to play their part – inflation and recession in the new zealand economy speech by dr alan bollard, governor of the reserve bank of new zealand, to the wellington chamber of commerce, wellington, 10 december 2008. * * * the world economy faces some significant challenges. finance markets have been going through turmoil, the pace of global expansion has slowed abruptly, and policymakers have focused on preventing a more pronounced slowdown. for some commentators, concerns over inflation appear to have taken a back seat, for now at least. as the global economy has weakened, commodity prices have fallen, substantially in some cases. many commentators are of the view that lower commodity prices and weak economic activity will drive inflation significantly lower. it is worth remembering that for the moment, however, inflation rates in new zealand ( and many of our trading partners ) remain very high. in the september 2008 year cpi inflation reached 5. 1 percent, the highest rate since 1990. the higher rates of inflation are broadbased. these reflect some common drivers : • a strong run - up in world commodity prices, which have had a direct inflationary impact. oil prices increased nearly tenfold in usd terms in the decade to july 2008, with global food prices also rising strongly. prices of the milk, cheese and eggs category rose 18 percent over the last year. • the long - running expansion in domestic demand contributed to a build - up of pressures on capacity and high rates of domestically generated inflation. so far, weaker demand conditions have been slow to feed through into lower domestic inflation. in the building industry for example, rising prices for raw materials and strong wage inflation have continued to underpin high rates of construction cost inflation. • there have also been sizeable price increases in areas not directly exposed to a high degree of competition over the past few years. increases in local authority rates have run well in advance of overall cpi inflation for a number of years. cost increases in some utilities have also been notable, particularly electricity. • in the banking sector, the cost of international funding has risen significantly and become less assured. however, since july the reserve bank has cut the official cash rate by 3. 25 percent. short term mortgage rates have been cut, but not by this much. banks should not expect to be able to maintain high profit margins in the current environment. table 1 consumer price inflation over the 3 years to 2008q3 cpi component average annual rate for the 3 years to september 2008 quarter annual percent

monetary policy statement projections are for annual cpi inflation to trough around 1½ percent in the september 2009 quarter, before lifting slightly above 2 percent thereafter. headline cpi and inflation expectations ( annual ) source : statistics new zealand, rbnz estimates. we need to see inflationary pressures reducing significantly across the board, if we are to keep on easing monetary policy, thus helping the new zealand economy to recover. that depends on all sectors of the economy responding to the reduced demand and not adding inflationary pressures to the system. some examples : we would hope that the electricity industry does not take advantage of its market position and keep increasing rates, that local authorities realise they need to set rates increases below inflation for a change, that the construction materials industry respond to much weaker demand, that the food industry react to lower international commodity prices with price cuts, that petrol companies keep cutting forecourt prices, that the transport industry pass on fuel price cuts, and that the banks pass on interest rate cuts. only then will all these firms be playing their proper role in new zealand ’ s recovery.