do not see pressures that have the potential to get out of control, then we have a mandate to be a little more flexible in our response. is this increased flexibility justified? in other words, can we be a little more flexible than in the past without taking risks with price stability? i think we can, because keeping prices stable gets easier when prices have already been stable over an extended period. if inflation suddenly rises just after a period, like in the 1980s, when it was out of control, then there is a risk it will spark a self - fulfilling belief that it is out of control once again. in other words, if people believe that inflation is out of the bag, they may translate that into higher prices for the goods and services that they sell and higher demands for increased salaries and wages. by contrast, after inflation has been low and stable for a long time, people are much less likely to see price fluctuations as the start of something serious. then a self - fulfilling prophecy is much less likely. our freedom to be more flexible without compromising our price stability goal is thus a consequence of the hard - won achievement, during my predecessor ’ s tenure, of an environment where prices are expected to be broadly stable over time. in operating monetary policy, we will continue to carefully monitor people ’ s perceptions of the inflation outlook, to confirm that their confidence in price stability remains strong. what then of new zealand ’ s current economic situation? as you know, the new zealand economy has been going through a strong period, stimulated by international conditions favourable for us. we have had record tourist numbers, and excellent returns on dairy products and many other agricultural commodities. we ’ ve also had a very quick turnaround from a net outflow of migrants a year or so ago to a very strong net inflow, which has more than doubled new zealand ’ s population growth. in combination, these factors have led to pressure on new zealand ’ s resources. for example, many firms have seen strong demand for their products. this particularly applies to firms in sectors like retailing and construction that supply new zealand households. when they ’ ve tried to expand to meet that demand, employers have reported difficulty finding additional staff. this tends to create pressure on prices, and indeed, at present, inflation is near our price stability ceiling. but we run policy looking forward, and it has not been clear how long the effects of that offshore stimulus will last. in the united states the long expansion has given way to recession

into law. maintaining price stability, as i am required to do, is different from firstly having to achieve it, as was required then. as you know, before becoming governor, i signed a new policy targets agreement with the minister of finance. this new agreement offers monetary policy a bit more scope to take evolving circumstances into account. in particular, the new agreement makes clearer that the reserve bank should maintain price stability in a flexible way that does not unnecessarily disrupt the real economy. the key change in the agreement is that the inflation target has been explicitly defined in terms of “ future inflation... on average over the medium term ”. this implies that monetary policy should be forward - looking, and avoid getting distracted by transitory fluctuations in the inflation rate. in typical circumstances, we expect to give most attention to the outlook for cpi inflation over the next three or so years. if the outlook for trend inflation over that period is inconsistent with the target, we will adjust the official cash rate. our intention will be that projected inflation will be comfortably within the target range in the latter half of the three year period. this means we will set policy so that inflation will be within the target range in the medium term, unless we are hit by a major surprise event. if a major surprise does occur, we will explain what has caused inflation to be higher or lower than we wanted, and what steps we will take to ensure that it goes back comfortably within the band. i said the new policy targets agreement offers us a little more flexibility, but it ’ s a flexibility that needs to be applied with care. the language of the new agreement makes clear that inflation should not be persistently outside either end of the band. this is because a sustained breach of the target could affect people ’ s perceptions of the trend inflation rate. that in itself could create a major inflationary problem. thus, if one of the disturbances i mentioned earlier appeared to be strongly stimulating or weakening activity in new zealand - suppose there was a sharp and persistent increase in tourist numbers for example - then the inflationary consequences might not be transitory. so, to keep inflation from rising and activity from going through a boom - bust cycle, monetary policy still needs to act to counteract the impact of these disturbances. and monetary policy still needs to respond particularly assertively when inflation is expected to be well outside the target range, or persistently outside it. but, at other times, if inflation is fairly stable and if we