alan bollard : agriculture, monetary policy and the economy speech by dr alan bollard, governor of the reserve bank of new zealand, to federated farmers, nelson, 18 july 2006. * * * the experience of the last decade has been that agricultural prices and agricultural production remain as important as ever to the new zealand economy. ten years ago we expected to see an economy evolving with a gradually diminishing relative role for primary production, fewer tonnes of produce, more specialised value added, less growth in labour and more value added. some of this has happened. but we have also seen growth in volume of exports and more labour participation. and we still see a direct relation between the health of primary production and the health of the new zealand economy. we have been through huge technological changes signalled by the birth of the internet. but at the same time the renewed vigour of globalisation has brought some old - fashioned features - a big increase in emerging market economies'appetite for resources on the one hand ; and fewer obstacles to getting their manufactured goods to first world markets, on the other. at a time when the future of the doha round looks so fragile, it is ironic to see the gains we are getting from past improvements in global connectedness. related to this has been a strong supply of cheap capital into the world's financial markets. the new zealand economy has been through a long period of expansion since 1999, probably the second longest period of continuing growth since world war ii. source : rbnz. when we look for the causes of this we see two main factors. first, much of the world has also been through a strong period of growth ( despite some emerging market economies'financial crises, the 9 / 11 crisis, and the fear of deflation ). second ( and related ), we have enjoyed strong commodity prices through this period, and they are closely correlated to export prices. there is some evidence that these improved prices might be expected to continue in the future. source : anz national bank, statistics new zealand. as ever, a small open primary - producing country like ours can be subject to considerable volatility, much of it beyond our control in the short - term. we know that climatic factors, especially drought, can be big enough to make a difference to the timing and magnitude of exports. however, tracking these through changes in milk production, dairy product storage, slaughter numbers, onshore and offshore inventory, can be surprisingly complex and lead to

much bigger in gross terms. they, however, look much less balanced because such a dominant proportion of their assets are held in housing, with a relatively small proportion of wealth held in equities, bonds and other instruments. this is in contrast to other oecd countries. source : oecd, rbnz. this is worth focusing on because the same phenomenon is happening to a large extent in the farming sector. farmers are unusual because statistically they constitute both households that consume and businesses that produce, thus complicating analysis of balance sheets. but when we look at farms as a business we see some trends that look rather like urban households. source : quotable value ltd. farmers with strong pay cheques over the last five years have been responsible for some of the pressure on housing and on second homes around the countryside ( one reason why this housing boom has been much more regionally diverse than the auckland - dominated house boom of the mid1990s ). source : reinz. in addition, agricultural land prices have been bid up significantly, a consequence partly of good commodity prices, partly of farm aggregation, partly due to productivity increases, partly due to fonterra - supply effects, and partly due to the availability of cheap credit. we have seen a strong period of lending to the farming sector. these are largely rational reasons why farmers might be willing to pay higher prices. source : rbnz. however these values are changing the nature of some farm balance sheets : it has become increasingly hard to try to rationalise prices paid for land using estimates of the future flow of income from the land. such estimates have always revealed a " rural lifestyle premium " for agricultural land, but this premium is now starting to look rather unrealistic. higher prices for land have looked reasonable when compared to product prices in past years. returns to farming were very good until 2003, as the unusual mix of high international commodity prices and a low new zealand dollar combined to make farming more profitable than any time in the past 30 years. but do high land prices today reflect the future income stream available from the land, or past effects? farmers are effectively saying they expect good export prices to continue into the future. but for land prices to continue to grow at these rates requires improbably high increases in export prices and productivity. there appears to be a gap opening up between land values and expectations of returns. future investment decisions should not be based on the expectation of ongoing double - digit growth in land