Prospects for a rapid recovery from New Zealand's partly self-imposed recession were fading fast, Berl senior economist Ganesh Nana said yesterday.
"It is becoming increasingly clear the New Zealand economy is in for a long period of sub-trend growth."
Sub-trend growth was a polite way of saying that the country's economic performance would be below what it should be, he said.
The outcome should not be a surprise. It was partly the result of the economic policy settings specifically designed to keep medium-term inflation under control.
With negligible prospects for employment growth in the next few quarters, the primary mechanism holding the New Zealand economy together would be commodity prices, Dr Nana said.
Dairy incomes were set to underpin several rural areas, and income tax cuts, when they arrived, would provide a welcome relief to the "grizzly negative news" that had been dominant recently.
"Other drivers of growth that we have pointed to in the past have now sunk without trace."
Business investment surged for a while but was now prematurely curtailed by punitive interest rates and a miserable outlook for income or profitability growth, he said.
The labour supply response in the form of surging participation rates had also ended.
On top of that were world oil price increases and the ongoing international credit crises.
As investors took cover and sat on the sidelines, shares and other asset prices had taken a hammering, Dr Nana said.
"Consequently, a horribly frightening stagflation scenario is almost upon us. Policy must respond decisively."
The first thing needed to be done was repealing section 8 of the Reserve Bank Act and tearing up the policy targets agreement which said inflation had to be kept within a 1% to 3% range, he said.
Statistics New Zealand figures this week showed inflation at 4%.
Most economists pick inflation to be at 5% or above by September.
The policy target agreement needed to be replaced with targets that served the needs of the wider economy.
Policy makers needed to:
• Cut interest rates now and allow the exchange rate to fall to a more export-friendly level.
• Adopt an economic policy framework that put an export growth target on the same footing as the inflation target.
• Closely monitor and regulate money and credit supply to ensure its growth was consistent with the previous two targets.
• Cease paying lip service to productivity and competitiveness goals by having business-friendly and growth-friendly policy settings that openly encouraged investment spending on training, research and development and network infrastructure upgrades.
"Most importantly, both developing and developed countries need to abandon inflation targeting. The weaker economy and higher unemployment that inflation targeting brings won't have much impact on inflation.
"It will only make the task of surviving in these conditions more difficult," Dr Nana said.
• Stagflation is a macro-economics term used to describe a period of inflation combined with stagnation - slow economic growth and rising unemployment - and generally including recession.
