it below 3 per cent, monetary policy should be able to protect the economy from any prolonged deflation and the loss of output and employment which that would entail. we have spent much of this decade fighting to keep inflation below the top of the target agreed with government. it is at least possible that, over the next year or two, we will be working to prevent it from going through the bottom of that target. we will be as singleminded in that objective as we were in the earlier challenge. indeed, we have been easing monetary conditions for more than a year with exactly that objective in view. having said that, we also need to be mindful of the risks in ignoring the long lags with which monetary policy works. if we ignore those lags, we run the risk of making economic cycles worse. alan blinder, former vice - chairman of the federal reserve board, sometimes uses the analogy of the thermostat. who has not checked into a hotel room and turned up the heating because the room is too cold? then, after having a shower, turned the heating up some more ‘ pioneering price level targeting : the swedish experience 1931 - 1937 ’, by claes berg and lars jonung. because the room is still cold. and finally woken up two hours later in a sweat, with the room like an oven. it takes time for central heating to warm up a room. it takes time for an easing in monetary policy to offset a sharp increase in deflationary pressures. if we keep easing until activity actually starts picking up strongly, we run the risk that in a year or two we will need to be slamming on the brakes. as we have sanctioned very substantial easing over the last year, we have been conscious of this risk. we have been conscious also that, with the sharp fall in the exchange rate which has taken place, import prices may be pushed up, with a risk that this might spill over into more generalised inflationary pressures. we recognise that, even now, with confidence quite low among both businesses and households, there is a strong increase in activity in some parts of the economy, particularly in those parts of the manufacturing sector which have benefited most from the fall in the exchange rate. in short, while we can not eliminate cycles in economic activity, we believe that monetary policy aimed at price stability can smooth economic cycles to some degree. this means that when inflationary pressures increase, we can be relied upon to tighten. it means that

i said in releasing our may monetary policy statement, it is not at all difficult to envisage circumstances where the new zealand economy grows more slowly than projected. indeed, it is possible to imagine scenarios where the world economy at least is quite weak. the external environment is not good, and could get markedly worse. to complicate matters still further, new zealand enters this period of international turbulence with a balance of payments deficit exceeding 7 per cent of gdp, and a negative net international investment position ( overseas assets less liabilities to foreigners ) of some 80 per cent of gdp, both high figures by international standards. but we have many strengths so we face serious challenges. but having established that i am fully aware of that fact, allow me also to note some of the advantages we have in dealing with those challenges. first, while a little over one - third of our exports go to east asia, almost two - thirds do not. and many of those other markets continue to grow strongly at this stage. in the three months to april, new zealand ’ s exports increased by nearly 30 per cent to the united states ( our third largest market ) as compared with the same three months in 1997, while those to belgium and italy increased by more than 50 per cent. even exports to some parts of east asia increased during that period - to hong kong by 29 per cent and to singapore by 27 per cent. while tourist arrivals from korea in the month of may were down 89 per cent as compared with the year earlier level, and from thailand by 64 per cent, overall visitor numbers were down only 7 per cent as a result of increases in tourists from the us, britain and australia. our exporters and tourist operators are showing considerable ability to switch from weak markets to more buoyant markets. the decline in the new zealand dollar against the currencies of the united states and europe has greatly helped in this re - orientation of our markets. secondly, we go into this period of international turbulence without the grossly over - inflated asset prices which have been such a serious problem in many of the countries of asia, and which were such a serious problem in japan in the late eighties and early nineties. it is the pricking of these asset price bubbles which has often done so much damage to banking sectors and, as a consequence, to the real economies of the countries affected. yes, i have at times lamented the high prices paid for both houses and rural land in new zealand. i remain convinced