The Reserve Bank faced questions from a Government MP today about why it couldn't cut interest rates to drive unemployment even lower. It argued in response further rate cuts could inflate the housing market again and it preferred interest rate stability to taking a risk that inflation could reappear.
Retiring Reserve Bank Acting Governor Grant Spencer defended his decision earlier on Thursday not to lower interest rates before the Finance and Expenditure Select Committee. Some economists have called on it to cut rates to further stimulate growth and lower unemployment.
The bank thinks that the economy is close to reaching the Non-Accelerating Inflation rate of Unemployment (NAIRU). A forthcoming paper from the bank will argue that this sits around 4.7 percent.
Employment statistics released on Wednesday by Statistics New Zealand show the current rate of employment to be 4.5 percent, while inflation remains in the bottom-half of the Reserve Banks' target range at 1.6 percent.
Labour's Michael Wood, chair of the committee and a Parliamentary under-secretary, asked Spencer whether there was more headroom for a more accommodative monetary policy, given unemployment is not projected to fall below 4% by 2021.
"Given the growth story and the capacity story there is going to be the question of when inflation is going to come back," said Spencer.
"We don't think it's a good thing to have policies that chop and change. We have a steady hand on the tiller, rather than having to negotiate each wave," he said.
He noted that given the current economic climate, with investors and policymakers nervous about an impending correction, it was important to maintain stability.
"When you look at the international scene and the sort of thing that you had last week which showed that people are getting nervous about a pickup in inflation globally...if that happens then that would make us revise upwards our projections for inflation and potentially interest rates so that wouldn't look too good if we were easing rates and having to move back in the other direction in a short space of time," said Spencer.
Spencer went on to detail the other key concern in the bank's decision-making: the housing market, which had begun to slow.
"Any reduction in the interest rates could risk reigniting the housing market, causing debt-to-income ratios to increase. Household debt is very high at 168% of the average household income and we're just getting to a point where it's starting to come off," he said.
"The risk is that if we reduce interest rates more people will go out and get mortgages and that debt ratio might start to increase again."