so would simply spread inflation and harm the recovery. the extent of indexation in the economy is much less than it was decades ago, but there are still some wage and price adjustments that are unavoidably linked to the consumers price index. the 1 october income tax reductions mean most people are already compensated for the effects of the gst increase. given this, there is less argument for one - off cpi - indexed wage increases. a particular message of restraint is for those parts of the economy, both public and private, that have a record of increasing prices by more than the rate of economy - wide inflation. we expect to see relative prices change in a well functioning economy. in a competitive market they represent an important signal for resources to move around the economy in search of more profitable opportunities. a good example is the agricultural transformation that has occurred with the rise in dairy prices. there may also be public policy reasons why some prices move more than others. but there are also examples of persistent price increases in sectors that have not suffered persistent cost increases, and these have an inflationary effect. the diagram shows the impact of excise tax increases on alcohol and tobacco industries, and that the energy and local authority sectors have recorded persistently high price pressures. given the fragility of the recovery it is important that firms base their pricing decisions on low underlying inflation, and not the forthcoming temporary spike. monetary policy would need to respond if inflation expectations and prices were ratcheted up significantly. the result would be higher interest rates and a dampening of the economic recovery. we are hopeful this will not need to be the case, so that monetary policy can play as full a part as possible in supporting economic growth.

are reviewing the scope for managing capital flows. capital controls may be appropriate in some circumstances, perhaps to mitigate problems arising from temporary surges in capital inflows in economies with weak financial sectors. for a debtor country like new zealand, an open capital account is essential. introducing capital controls, instead of making the necessary adjustments, would damage the credibility and bis central bankers ’ speeches stability of new zealand ’ s financial sector, and increase the real cost of capital for new zealand. reducing interest rates can at times reduce pressure on the exchange rate but analysis of past ocr cuts in new zealand shows on average minimal or no intra - day impact on the exchange rate, and even less impact on a weekly basis. analysis of “ unexpected ” ocr changes with trade weighted index changes following a rate decision still does not show a strong relationship to subsequent movements in the exchange rate. this reinforces the idea that the exchange rate primarily reflects returns in the broader economy rather than simply returns in the money market. we set the ocr such that the inflation outlook remains consistent with the pta and the financial markets understand this. if we reduced the ocr without sound reasons the exchange rate might drop initially but rise later when the inflationary implications of the rate cut became clear, especially if the belief was formed in the meantime that the central bank ’ s commitment to price stability was wavering. foreign currency intervention is unlikely to have a sustained impact on the new zealand dollar, but can have an impact in the short term if the reserve bank makes the right calls about the exchange rate departing from fundamentals. the reserve bank has four criteria to assess whether intervention should be undertaken. these are : whether the exchange rate is exceptional relative to history ; is the exchange rate justified ; would intervention be consistent with the pta ; and whether the market conditions exist to successfully shift the value of the currency. even if the first three criteria are satisfied at a point in time, it makes little sense to risk incurring losses to taxpayers by intervening when currency flows supporting the new zealand dollar are particularly strong. but we will remain vigilant on these criteria and will be prepared to intervene if all conditions are met. so there are clear limits to what monetary policy and exchange rate intervention can do to lower the new zealand dollar. in order to achieve a sustained reduction in the new zealand dollar it would be necessary to alter the overall level and pattern of saving and investment in the economy. in particular, it will be necessary to tackle our