and the knowledge and skills of the population. the quality of education is critical in creating opportunities for growth and increasing real income. we need to improve the evenness of our education outcomes. globalisation and technology have widened the distribution of income within most advanced economies, including new zealand, over the past three decades. in the mid - 2000s we had greater income inequality than most oecd economies, and this is unlikely to have changed. the bottom income deciles are populated by those with lesser skills, and those who experience prolonged and recurrent spells of unemployment. addressing these groups would both promote productivity and reduce inequality. our education system is well regarded internationally. we rank 7th among 65 countries in the oecd ’ s programme for international student assessment that tests high schoolers ’ performance across reading, mathematics, and science. but, we have the greatest difference in reading performance between students from different socio - economic backgrounds out of all oecd countries, and the pisa scores for maori and pacific island students are much lower than the average for students of european descent. over the past 15 years, unemployment rates for maori and pacific islanders have been three times that for the european population. how can the reserve bank best contribute to new zealand ’ s economic prospects? there are two main ways. bis central bankers ’ speeches the first is by delivering price stability and reducing the risk of inflation surprises. price stability, and expectations that future inflation will be both low and stable, contribute to economic growth in several ways. they reduce uncertainty as to future inflation outcomes and assist planning and long term contracting. they enable producers and consumers to identify relative price shifts and allocate resources in response to shifts in demand. they avoid the distortions created by the interaction of high rates of inflation and the tax system that lead to higher effective rates of taxation. and they reduce the incentive for investors to acquire non - productive assets, such as investment properties, as hedges against inflation. research by the imf suggests that in industrialised countries the threshold level of inflation above which inflation significantly slows economic growth is estimated at 1 – 3 percent. 2 in considering inflation pressures the reserve bank closely examines recent developments in the economy, and the outlook for competitiveness, demand, and output growth and employment. in setting the official cash rate we aim to avoid excessive volatility in output growth, interest rates and the exchange rate. we seek to respond to changing conditions but avoid rushing into decisions that might need to be quickly reversed and in doing so

more problematic : that is the investment income balance. this measures incoming earnings from the very limited amount of new zealand investment abroad against outgoing earnings from the much larger stock of foreign investment in new zealand. new zealand runs a large investment income deficit of around 6 – 7 percent of gdp, which is showing little sign of enduring improvement. indeed it will be difficult to improve this metric as that would require us to get our net external debt position on to a downward trend and that would require a significant change in historic patterns of inward and outward investment. these two components combine into the current account, which has been in significant deficit in new zealand for 40 years. that is not problematic in itself, but if it is consistently funding consumption rather than investment, then that cannot continue. the deficit worsened during the housing boom years of 2005 – 2008, sitting near 9 percent, a very deep deficit by oecd standards. interestingly, throughout the crisis we experienced little sign of financial market discomfort with that position. we are now experiencing a big improvement in the current account, reducing the deficit to 3 percent, but we believe it will deteriorate again as the recovery picks up. 3. our overall external imbalance years of running these external deficit flows means that we are now significantly in debt to foreigners : in plain terms, they have more than twice as much invested in nz ( $ 290 billion ) as we have invested overseas ( $ 125 billion ). this means the country is running a sizeable net investment deficit of around 90 percent of gdp. most of the debt inherent in this position is in the private sector, not the public sector. a significant proportion of this relates to the banking system which does most of the country ’ s offshore borrowing, effectively on behalf of households and businesses. most of it is currency - hedged, so we do not suffer major currency risks from it. the graph shows how the position has grown over the last decade. our forecasts see this external deficit continuing to grow. financial markets and credit rating agencies use a range of indicators to form their assessment of a country ’ s viability or fragility. at the moment most of the focus is on sovereign debt and the fiscal accounts. however as the recent credit downgrade of the government of spain showed, overall external indebtedness can play a role in this. new zealand is one of the very few developed counties with net external liabilities so high. the ubs country risk index mentioned above rates us rather higher in terms