are increasing are by their nature usually situations where demand in the economy is running ahead of the economy ’ s long - term capacity to supply, so that monetary policy aimed at restraining those inflationary pressures inevitably tends to dampen down booms. and conversely, those situations where demand falls short of the economy ’ s long - term capacity to supply are usually situations where inflationary pressures are falling towards zero, so that monetary policy aimed at preventing inflation falling below zero ( as required by my agreement with the treasurer ) inevitably tends to work to mitigate those downturns. in determining the stance of monetary policy, we are inevitably trying to assess what future inflation pressures will be. that means we are always trying to assess how demand pressures will evolve relative to the economy ’ s ability to supply. are we primarily trying to smooth business cycles? no, we are trying to maintain consistently low inflation within the target we have agreed with government, but one of the corollaries, one of the ancillary benefits, is that, if we get it right, the business cycle will be somewhat moderated also - less vigorous booms and less recessionary busts. as one of america ’ s leading monetary policy economists, larry ball of johns hopkins university, has recently argued, even if you were mainly concerned to smooth output and employment cycles, focusing monetary policy on delivering predictably low inflation would be the most sensible way of running monetary policy. so let ’ s make this abundantly clear. the reserve bank has not had some sort of road - to - damascus experience. we have not decided that inflation matters less and that we have to ‘ go for growth ’. we have not decided to fix the current account. we have not decided to get the farmers back in the black. and we have certainly not, as columnist chris trotter put it, anticipated ‘ the national government ’ s political needs ’. the easing process that is now underway is absolutely intrinsic to, and an inevitable result of, the monetary policy framework that has applied in new zealand since the passage of the 1989 reserve bank act. more precisely, it is the inevitable result of an inflation target which has an upper and a lower limit. recent events are therefore just ‘ business as usual ’. recent changes in interest rates and the exchange rate but, you ask, hasn ’ t the reserve bank just deliberately knocked down the exchange rate and increased interest rates? doesn ’ t that suggest that the bank has taken its eye off the price stability ball,

can debate whether the bank ’ s monetary conditions index is correctly calibrated, whether a 2 per cent fall in the exchange rate is equivalent to a 100 basis point movement in 90 day interest rates. one can debate whether the bank ’ s trade - weighted index correctly measures movements in the new zealand dollar. one can debate whether the 90 - day interest rate correctly measures movements in new zealand interest rates. and i am familiar with all of that debate. ( we dealt with several of these issues in the march 1998 economic projections, and in my speaking notes for journalists in releasing that document. ) but if we accept, as i believe we must, that in a small, open economy monetary policy works to affect the real economy and, in that way, inflation through both interest rates and the exchange rate, then i don ’ t have the slightest doubt that overall monetary conditions have eased in new zealand in recent months, and indeed have eased quite considerably. that easing has taken the form of a sharp fall in the exchange rate which has been partly offset by an increase in short - term interest rates ( the increase in longer - term interest rates has been much more moderate ). i have often conceded that the mci is not a perfect measure of monetary conditions. we will continue to seek ways to improve it. but as a rule - of - thumb to guide financial markets between quarterly projections it has proven enormously useful. it has assisted us through a very major rebalancing of monetary conditions at a time of great turbulence in financial markets internationally, with an absolute minimum of drama. yes, interest rates have gone up, but given our balance of payments deficit - or in other words, our huge appetite for borrowing and our national aversion to saving - that should not be a matter for surprise or regret. if as a nation we become less enthusiastic about borrowing or more enthusiastic about saving, we can expect interest rates to decline to the levels which would seem to be justified by our low inflation. in conclusion, i think it is important that we all look at recent events objectively. right now, the new zealand economy is having to adapt to a complex set of circumstances, including an increase in government expenditure, a reduction in taxation, a changing housing market, and, coming rapidly over the horizon, the negative implications of the asian financial crisis. yet what we see is adjustment to these new circumstances, taking place within existing structures, without great drama. monetary policy, with its single focus on price stability and