as discussed in our monetary policy statement last week, there are those who believe that recent us experience, with rapid growth and low inflation, points towards some new ability for modern economies operating with the latest technology and in competition with producers from all over the world to grow more rapidly than previously believed without inflation. local optimists argue that new zealand too could see more rapid growth with low inflation if only the reserve bank were not so cautious. others suggest that, even in the us, the conjunction of low inflation with rapid growth has reflected in large part the disinflationary impact of some one - off factors, such as the recent weakness in world commodity prices, and the recent strength of the us dollar. they note that there is not yet any strong evidence in new zealand to suggest that there has been a significant increase in the trend rate of productivity growth of the sort which might be required to justify a belief in the “ new paradigm ” in new zealand. as our statement last week noted, we are not yet persuaded that there is evidence of any fundamental change in the relationship between growth and inflation in new zealand. but we are open - minded on the issue, and will continue to examine the data for evidence of such a change. indeed, a whole section of the statement was devoted to acknowledging that, while we have no doubt about the need to reduce the stimulus which monetary policy has been providing to the economy in recent times, there is much less certainty about how far monetary policy will need to tighten beyond the next few months. conclusion and this is my main message to you today. all the evidence suggests that, after a very brief recession two years ago and growth of 3 to 4 per cent per annum since the middle of 1998, the excess productive capacity in the economy is largely gone. ( in other words, referring back to my graph, we have passed point e and the demand line is very close indeed to the supply line. ) it was appropriate that monetary conditions were stimulatory while demand fell well short of capacity. if we are right that demand and supply are now close to balance, however – and there is now a large body of official statistics and unofficial anecdotes supporting this view – it is high time that this stimulus was removed. and of course that is what we have been seeking to do with the increases in the official cash rate in november, january, and now in march. we project that we will need to continue this reduction in stimulus, this easing back on

of confidence in market forces, it feels a bit strange to have to disagree with those who advocate letting market forces be the sole determinant of interest rates. of course, market forces do determine interest rates to a very large degree. central banks really have a strong influence only on short - term interest rates. but why do we need central banks at all? this is not the place to give a comprehensive answer to this question. 1 but it might be worth noting that, to the best of my knowledge, no country in the world currently operates without the services of a central bank. in other words, all countries that i am aware of have their own central bank, or effectively use the services of another country ’ s central bank ( through using that other country ’ s currency, or tying their own currency to that of some other country ). and all of those central banks intervene, as we do, by influencing short - term interest rates. what about the balance of payments? surely, the reserve bank and its obsession with price stability have been a major contributor to the large current account deficit which new zealand has experienced over the last decade? well, actually no. new zealand has had a current account deficit in every year since 1974, through a range of monetary policy regimes. indeed, the largest deficit experienced over that 25 year period, relative to gdp, was in the mid - seventies, with another very large deficit in the mid - eighties. i am myself absolutely persuaded that, even if the reserve bank act were amended to make the bank responsible for reducing the balance of payments deficit, monetary policy has no ability to produce any sustainable reduction in that deficit. indeed, i do not even know whether reducing a current account deficit would involve tightening monetary policy ( which would push up the exchange rate but slow down domestic spending ) or easing monetary policy ( which would tend to push down the exchange rate but accelerate domestic spending ). but surely it was daft for the reserve bank to tighten policy just as the new zealand economy was emerging from a recession? well, it might have been daft to do that if that is what we had done, but of course we did not. new zealand experienced a brief, mild, recession in the first half of 1998, in significant part because of the impact of the asian crisis and of a severe drought. but the economy but see “ monetary policy and the free - market economy ”, an address to the auckland manufacturers ’ association, 22 february 1996. started growing again in