and medium - term inflation pressures. short - term changes in prices can affect people ’ s expectations about inflation, but it has usually been sensible for us to “ look through ” these effects. if we did not, we would typically be over - reacting, and pushing interest rates around more than medium - term considerations would warrant - and that might even exacerbate exchange rate fluctuations over time. some, of course, would suggest that we should be more active and should adjust the ocr, not just to offset the dampening impact of the exchange rate, but to try actively to reverse, or slow, the rate of increase in the exchange rate. in this case, of course, it is important to remember that the exchange rate has simply recovered to more normal levels, pricing new zealand assets and products more sensibly, albeit adjusting more quickly than is comfortable. and more generally, we need to be very cautious. we would be the first to acknowledge that monetary policy affects exchange rates, but modest changes in interest rates only rarely do so in a stable and predictable manner over periods that matter to people in the real economy. understanding, after the event, what has driven the exchange rate is one thing, but reliably forecasting it, or using monetary policy to influence it, is quite another. what we constantly do, however, is to look behind developments in the exchange rate. we want to understand as well as we can what has been going on and why, and we continually test our reasoning and judgements to ensure that our monetary policy decisions are not unnecessarily exacerbating exchange rate changes. this prudent and sensible approach has in fact been written into our mandate - the policy targets agreement with the minister of finance - since 1999. it keeps our focus on medium - term price stability, but requires us to ensure that in pursuing that medium - term goal we avoid unnecessary instability in output, interest and exchange rate. there are no simple answers as to how to apply these provisions to our policymaking ; to know just what is “ unnecessary ”, not just right now, but over the medium - term. sometimes, an ocr rise will exacerbate pressure on the exchange rate, but rises in both will be a necessary response to pressures on output and inflation. at other times, there will be scope for trade - offs, but there are rarely easy or reliable ones. for us, those choices might come more sharply into focus if we were to

the exchange rate was something of a mixed blessing. that is perhaps always the case. a falling exchange rate does tend to be good for producers - firms and farmers in canterbury for example - but it is bad for consumers. it tends to feel better in the countryside than in the cities. it makes our wages look less attractive to prospective skilled migrants, but our beachside houses also appear cheaper to those wealthy foreigners looking for an antipodean holiday home, and so on. from a macroeconomic perspective, how we feel about these departures from “ equilibrium ” ( and our best assessment of that equilibrium level is somewhere in the range of 54 - 60 on the trade - weighted index ) depends a lot on what else is going on. in this case, the low exchange rate happened to provide a timely buffer when the world economy slowed down sharply : for exporters of manufactured goods and services, in particular, it provided an offset to the impact of the sharp slowdown in world economic activity. but for a variety of reasons, our economic growth proved so robust that new zealand was one of only a small number of countries that needed to raise interest rates quite a bit last year to help keep medium - term inflation pressures in check. the exchange rate had become too low for too long to really be helpful. and eventually, as these things do, the exchange rate began to correct - although no one could really reliably predict when this correction would get under way. in trade - weighted terms, our exchange rate has now risen by around 20 % since the end of 2001 ; one of the largest twelve - monthly changes that we have seen in the 18 years since the exchange rate was floated. it is important to put this in context though : even after a striking 30 % rise against the us dollar, that exchange rate is still only now around its average level for the last 10 years. on a trade - weighted basis, the exchange rate is now only a few per cent above its long - term average. as i noted earlier, changes in investors ’ attitudes and expectations tend to be the main prompts for substantial exchange rate moves. how did those attitudes change last year? for investors, the us “ miracle ” has turned sour. share prices have fallen for three consecutive years, and even us interest rates are unattractively low by international standards. america ’ s need to attract foreign capital - its huge current account deficit - remains as strong as ever. but when the us is no longer flavour of the decade