currency had been pegged to the au dollar, new zealand ’ s exchange rate to the rest of the world would have been higher, interest rates would have risen three times already, and our recession would probably have been deeper. the argument is even stronger for other currencies, such as the us dollar. australia and new zealand are not the same, but we are far more similar to each other than to europe or the us. if our currency had been pegged to the us dollar over the past decade, interest rates would have been lower for longer in 2003 and 2004, exacerbating the housing boom ( figure 3 ). some of the challenges of a currency union can now be seen in euro area economies such as ireland, greece and spain, where monetary policy settings have been unable to lean against unsustainable domestic booms, or against the deep recessions that followed. figure 3 policy interest rates in nz, the us, and australia source : bloomberg figure 4 gdp growth in euro area economies source : datastream singapore ’ s monetary policy regime is sometimes pointed to as an alternative to inflation targeting that has maintained stability in the currency while achieving a track record of low and stable inflation. over the past two years, of course, this has not been the case, with inflation approaching 8 percent in 2008 and prices falling in 2009. over a longer period, it does appear that singapore has generally managed to guide its exchange rate to keep inflation stable. but a range of special factors made this possible – singapore ’ s extraordinarily high trade ratio, its large stock of domestic savings and foreign exchange reserves, and a range of supplementary stabilisation instruments and capital controls. in particular, in new zealand, with its much larger non - traded sector, a singaporean regime might potentially have required greater swings in the exchange rate than we actually saw to achieve similar inflation outcomes. global policies, the tax system and financial stability also matter a lesson from this period is that while monetary policy can always achieve price stability, whether this occurs in the context of balanced growth also depends on other factors. as the housing boom has shown, these factors include global policy settings and the structure of the tax system. looking back over two years of crisis, perhaps the key lesson is that financial stability cannot be ignored when thinking about macroeconomic stability and the conduct of monetary policy. we ’ ve been reminded that financial system developments have the potential to complicate monetary policy enormously, and that stable prices do not

in information technology, where energy prices were low and the costs of a wide range of manufactured goods were falling rapidly ; a challenging period of sharply rising commodity and asset prices in the past few years ; and the extreme ructions of the global financial crisis. this can be seen from figure 1, which shows new zealand cpi inflation since 1980, as well as a survey measure of 2 - year ahead inflation expectations. in particular, while inflation expectations crept up in the boom years, and fell back sharply in late 2008 as the financial crisis hit, they have remained well - anchored across that time period. figure 1 new zealand inflation and surveyed inflation expectations source : statistics nz, rbnz inflation targeting has supported, but not guaranteed, macroeconomic stability in taming inflation expectations, the inflation targeting framework has removed a major source of economic volatility. it has also allowed for active macroeconomic stabilisation in a broader sense. most notably, once the global financial crisis hit, we were able to respond with significant policy easing swiftly, cutting the ocr by more than 5 percentage points and providing banks with emergency liquidity at rates consistent with the ocr, at a time when the international wholesale funding markets were severely impaired. we were able to provide this degree of support because the inflation targeting framework allowed for a flexible response, and inflation expectations were well anchored. however, the extent of the financial crisis makes it clear that inflation targeting monetary policy has not been sufficient to guarantee comprehensive macroeconomic stability. recall the decade or so from the second half of the 1990s to the late 2000s that many commentators called the “ great moderation ” or the “ goldilocks ” economy, when many economies experienced an extraordinarily long stretch of unbroken strong growth. even then, we continued to see large movements in commodity prices, house prices, interest rates, and exchange rates. there were also significant shifts in the composition of growth, from the traded to the non - traded sector, and big increases in household and external indebtedness. some of these changes were structural, such as the rise in the global demand for agricultural and other commodities from the late 1990s onward, or the surge in migration to new zealand in the early 2000s. some of the price movements were beneficial in helping the new zealand economy adjust to those changing conditions. but we also saw growing economic imbalances, and the commodity and asset price rises in the years leading up to the financial crisis were among the hardest challenges faced by central banks over the past 20