World Economy

What other policy mechanisms could work alongside interest rates to ease inflationary pressures?

There are a number of other measures that could potentially reduce pressure on interest

rates and therefore, the exchange rate pressures on exporters.

Some measures support interest rate changes and would impact households directly. Others limit the need for an interest rate rise, for example, tighter control over government spending and regulation.

Some options are politically and economically unpalatable. Others have potential and are worthy of further investigation. However, as with the mortgage levy proposal, when one digs a little deeper, all have flaws. There is certainly no "silver bullet".

The options include:

* Put a lid on central and local government expenditure

* Improve the quality of regulation

* Adjust interest rates more decisively

* Increase competition in markets

* Improve productivity

* Improve communication with the public and key international markets

* Improve responsiveness of housing supply

* Adopt a common currency

* Intervene in currency exchange markets

* Lower interest rates

* Restrict use of fixed-rate mortgages

* Modify tax rates temporarily

* Introduce a capital gains tax

* Restrict bank credit lending

* Make immigrants pay

Put a lid on central and local government expenditure

Capping the growth rates of central and local government operating expenditure would help control the inflationary pressures generated through additional spending. Annual

adjustments could be made to accommodate population growth and general inflation.

Although capping growth rates could impede the Government's ability to fund new

infrastructure, provision could be made for Government to seek public support for expenditure beyond the cap if necessary. Most government spending is on domestic

goods and services and increased demand puts pressure on prices and costs. Poor quality

expenditure, such as the introduction of interest-free student loans from April last year,

further undermines competitiveness. The OECD, for example, has been critical of some aspects of the Working for Families package. Increasing real government expenditure at a time when the economy is operating at close to full capacity brings further inflationary

pressures. Local government rating increases have generally exceeded movements in the

Consumer Price Index. Also, many central and local government services are not open to

competition and are therefore not subject to normal market pressures or disciplines.

The Government states it has been a prudent fiscal manager - despite a strong increase in Crown expenses and NZSF contributions since 1999/2000 and projections of further substantial increases.

The strongly performing economy has helped by providing large increases in revenue to cover substantial spending increases. Although restraint in withstanding calls to increase spending by even greater amounts has been admirable, there has nevertheless been a large

increase in spending - at least some of which is of dubious or unproven value.

The following examples could be considered areas of imprudent government expenditure:

1. Increased spending on Working for

Families :: This effectively makes three quarters of working families recipients of

social welfare. This redistribution policy increases administration and bureaucracy

and, some analysis suggests, creates poverty traps. Tax cuts would provide

greater incentives for all families and individuals to work harder and retain earnings for investing or spending as they see fit.

2. Interest free student loans ::

This effectively provides subsidies for students to spend beyond their means without incentives to retire the debts as quickly as possible when they graduate.

Students are encouraged into debt in the knowledge they are not subject to the normal pressures of debt servicing other individuals face.

3. Expanding local government rates rebates to low-income earners, irrespective of assets held :: This will reduce incentives on local government to seriously examine current expenditure and determine whether or not it is necessary for

the public good.

4. Increasing superannuation payments ::

Superannuation is not currently targeted at

those in greatest need, given that it is not

subject to income or assets testing.

Improve the quality of regulation

Most commentators consider the Public Finance Act to have lent support to the Reserve Bank in the sense that government spending and taxation policies have to operate within a relatively sound framework and focus on the medium term, rather than ad hoc pump priming of the economy in election years, which compounds inflationary pressures.

This requirement for tight controls on government spending may provide an incentive to shift more of the fiscal burden on to the private sector through regulation, thereby reducing the need for government to identify such expenditures in official budgetary processes.

This confirms the need for the Government to improve its regulatory processes through the adoption of a Regulatory Responsibility Act (or similar).

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The risks of not having such an Act to complement government spending are:

1. Government may be encouraged to shift more and more of its fiscal