price changes or from changes in indirect taxation. and when we look forward to the end of the year, it seems pretty clear that much of the sharp increase in inflation which is now expected by most commentators will be the direct result of such factors, and should as a result be ignored by the reserve bank in setting monetary policy. partly because we expressly don ’ t react to certain kinds of price changes, actual inflation can often be expected to fluctuate over quite a wide range - certainly over the full 0 to 3 per cent range, and occasionally outside that range. and we set interest rates with the objective of keeping inflation somewhere near the middle of the target range in one to two years ’ time precisely because we know that in practice there will be all sorts of unexpected shocks and developments, ranging from asian crises to changes in cigarette taxes, which will move prices both up and down, away from that mid - point. we improve our chances of having inflation remain within the target range most of the time by constantly aiming to keep inflation near the mid - point of the range in the medium - term. but we recognise that there will be all kinds of developments which will result in somewhat different outcomes, and indeed should result in somewhat different outcomes. but it is crucially important to stress that the reserve bank can ignore the impact of these one - off “ shocks ” to the inflation rate only if we new zealanders do not use them as an excuse to start a more generalised and enduring increase in the inflation rate. if a doctor, in reviewing his or her fees, says “ well, the cpi went up by 3 per cent, so i had better put up my fees by 3 per cent also ”, then we have a problem. if a producer of widgets sees that the cpi has increased by 3 per cent, and automatically puts his prices up too, then we have a problem. if local authorities see a 3 per cent increase in the cpi as adequate justification for them to increase rates and fees by that amount, then we have a problem. and if wages and salaries are automatically increased by 3 per cent to compensate for the increase in the cpi, then we have a problem. the reality is that, when the international price of oil goes up - to use the current example - we new zealanders become poorer, and it is utterly futile to suppose that we can compensate ourselves for that fact by giving ourselves higher incomes. to the extent that some new zealanders succeed in winning such compensation,

it has been harder than we might have wished to stimulate consumption. " the reserve bank and the treasury now have a work programme focused on whether there are ways to reduce the likelihood of finding our economy out of sync again ; or on handling it differently if we do. " what is clear is that in a globalised world most of the government's economic policies, including fiscal, industry and immigration policies, are all constrained by other countries'policies and by international pressures on them. with financial markets so interconnected, any small country's domestic monetary policy also now needs to be seen in an international setting. " nevertheless, there is no question that we can run an independent monetary policy. we have control of our ship. if global winds are not behind us or our economy is out of sync with influential economies, then our progress becomes more difficult, and things can get uncomfortable. we may have to modify our chosen course. " but with major economies now raising their interest rates, global conditions are becoming aligned to containing inflation. in these conditions, new zealand monetary policy is increasingly effective. indeed in some respects we are in a more comfortable position than some other countries, having already raised interest rates. " in the meantime, we are starting to see some other countries, especially small open commodity economies, realising this too as they start to face the same pressures. they have been following the new zealand experience with interest. "