07 jun - 07 mar - 07 dec - 06 jun - 06 sep - 06 mar - 06 dec - 05 - 4 source : national statistics office, bank of png staff calculations, world bank. other factors affecting inflation in png while food prices contributed to 60 percent of png ’ s inflation between march 2008 and june 2009, over the last year, they have only contributed about 35 percent. therefore, increasingly, additional pressures are contributing to inflation. after years of strong revenues, government spending has increased dramatically, contributing to strong domestic demand. additionally, png ’ s macroeconomic stability of recent years has led to increased business activity and foreign investment, most notably the png liquefied natural gas project which is currently under construction. moreover, due to the length of this boom in business activity, domestic demand pressures have consistently exceeded the ability of domestic supply to increase, and inflation expectations have increasingly become a factor in price setting and wage negotiations. with data collected from our business liaison surveys, we can see that wage expectations increased with the food and fuel price surge in 2008. but starting at the end of 2009 – even before the current food price surge began – we have seen wage expectations increase to their highest sustained levels since our survey began. when expectations of higher inflation are built into business costs, higher inflation can become entrenched, and monetary policy must then also decrease these expectations to reduce inflation. expected average employee wage change over the next year ( percent ) trimmed mean ( 50 % ) survey response q4 2010 q2 2010 q4 2009 q2 2009 q4 2008 q2 2008 q4 2007 q2 2007 q4 2006 q2 2006 q4 2005 q2 2005 q4 2004 q2 2004 q4 2003 source : bank of png staff calculations. bis central bankers ’ speeches thus, since 2007, inflation in png has been affected mainly by these factors : 1 ) external food and fuel prices ; 2 ) increased domestic demand due to high government spending, business activity, and lng project construction ; and, increasingly, 3 ) inflation expectations. role of monetary policy the bank of png has some tools to affect these inflation developments, but when it comes to externally driven factors such as food prices, png is a price taker, and the main challenge is for the bank to limit these prices passing on to other prices. moreover, with much of the current business boom driven by the lng project, the bank of png can only have a limited effect on demand

conditions. in this scenario, tightening monetary policy through increasing interest rates could potentially lower current consumption and demand to some extent ; however, this does little to affect imported food price inflation, government spending, and lng construction, although it could have a slight effect on expectations. moreover, a severe monetary tightening could increase the effects of dutch disease by reducing the ability of the rest of the private sector to expand. in fact, private sector credit growth has already slowed. although it was high up through early 2009, since then, it has decreased to a relatively low level of around 10 percent annual growth. otherwise, there is some potential for the kina exchange rate to appreciate further. this would lower the cost of imported prices, which would benefit urban consumers, while also dampening export revenue due to lower export prices in kina terms, which would negatively affect rural exporters and government revenues. between the first quarter of 2010 and the second quarter of 2011, food prices increased by about 34 percent in us dollar terms, while the kina appreciated against the us dollar by around 13 percent, thereby containing the price of imported food. however, kina appreciation would not be able to fully offset international food prices, or if it were, it would introduce volatility and require an unsustainable sell - off of international reserves. usd and kina food price indices usd food price kina food price q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q source : food and agriculture organization, bank of png staff calculations. this appreciation has come at the cost of exports, with the 13 percent kina appreciation against the us dollar moderating the export prices for both mineral and non - mineral exports, which rose by about 50 percent and 60 percent, respectively, in us dollar terms. however, even in kina terms, with mineral and non - mineral export prices much higher than one year ago, there may have been room for more appreciation of the kina. bis central bankers ’ speeches usd and kina export price indices usd mineral export price kina mineral export price usd non - mineral export price kina non - mineral export price q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3 q 20 1 q 20 3