When it comes to inflation, we are using obsolete tactics to fight an old enemy in new terrain, insists Peter Lyons.
We are not a society that values intellectual debate.
We seem to prefer the physical over the cerebral.
This is probably due to the small size and the relative youth of our country.
In the pioneering days physical prowess was essential to survival.
In the globalised world of the 21st century a lack of intellectual debate on policy issues can cost a society dearly.
We end up with debacles such as the introduction of NCEA or changes in lab testing that turn out to be a shambles.
A vibrant intellectual community provides a buffer against shoddy decisions by policy makers.
A current example is our blind adherence to damaging economic policy in the face of overwhelming evidence.
Our macro-economic management over the past 20 years has been based on an ideology called monetarism.
There is a serious lack of public discussion about the costs and benefits of this approach.
It is costing us dearly.
Our Reserve Bank has the task of keeping inflation between 1% and 3%.
An obsession with controlling inflation is at the heart of monetarism.
World financial markets are aware that New Zealand operates its economy based on this simplistic formula.
At the moment currency traders are betting the Reserve Bank will increase interest rates as inflation rears its ugly head.
This is because our economy appears to be heading out of recession.
The housing market is picking up and consumer confidence and spending is rising.
This usually leads to inflation.
Alan Bollard, the governor of the Reserve Bank, has stated that he is unlikely to raise interest rates until late next year.
Currency markets do not believe him.
They are picking an earlier increase and are buying New Zealand dollars in anticipation that others will do the same.
In global financial markets, perception is reality.
Mr Bollard finds himself in the bizarre position of trying to convince the currency market that he has gone soft on inflation.
This is despite his contractual agreement with the government to keep inflation between 1% and 3%.
This might seem a very distant concern for most New Zealanders but the practical effects are disastrous.
The New Zealand dollar has climbed steeply against the US dollar and the pound and held strong against most of our trading partners.
This is devastating for New Zealand exporters.
It has a real impact as firms close, relocate overseas and shed staff.
There are two questions we should be asking as the exporting lifeblood of our economy drains away.
Why are we so obsessed with keeping inflation between 1% and 3% and are the costs really worth it?Our inflation target of 1% to 3% is largely arbitrary.
The target used to be 0 to 2%.
It was changed when Winston Peters negotiated his coalition agreement with National in 1996.
Funnily enough, the sky did not collapse when the target was changed.
The reasoning behind this inflation target is that it reassures financial markets that New Zealand is serious about controlling inflation.
This is a legacy of the rampant inflation of the 1970s and 1980s.
Most economists would agree that we don't want a return to the double digit inflation of that period.
However, the world has moved on.
We are using obsolete tactics against an old enemy in new terrain.
There is no consensus in economic literature about what the ideal inflation target should be.
Using an explicit inflation target to kill the inflation monster of the 1970s and '80s was necessary.
People had built inflation into their expectations.
If inflation was 18% they would demand a wage rise of 20%.
This created a chase-the-tail scenario called a wage-price spiral.
Now our tight approach to controlling inflation has made us a prime target for currency speculators.
When currency traders believe the Reserve Bank will raise interest rates to meet its inflation target they buy into our currency.
We are seen as a safe one-way bet because of our naive transparency.
The New Zealand dollar has become a prized plaything in the casino of international finance, despite the fact that our economy is a minnow in world terms.
High levels of inflation are damaging to an economy.
It distorts people's behaviour but the medication is proving as damaging, if not worse, than the ailment.
The use of an explicit inflation target may no longer be the cure.
In a globalised world, this target sends a telegraphic message to currency dealers about the likely actions of our Reserve Bank.
Mr Bollard has recently stated that he is reluctant to reduce interest rates for fear of rekindling the housing market.
This tells currency traders that the next interest rate move will be up.
The big question is when? That is why our dollar holds firm against most currencies and climbs against some We don't want this, because it hinders an export-led recovery.
Mr Bollard is left bleating to the markets about the risks they are taking.
The reality is that if we continue to operate our economy in such a simplistic formulaic fashion the kiwi will continue to be a plaything and our exporters will suffer.
In a globalised age obsolete thinking can cost a country dearly.
Peter Lyons teaches economics at Saint Peters College in Epsom.
He has written several economics texts.
