Bank offers cuts advice

Press, 16 July 1986, Page 38

Bank offers cuts advice

PA Wellington Major fiscal policy reform, plus continued firm monetary policy, offers the best prospects for lasting cuts tn domestic interest rates, according to the Reserve Bank.

In an article id the June “Bulletin,” just released, the bank discussed the links between fiscal deficits (the amount the Government overspends Its Income) and interest rates. It said a cut in the size of the fiscal deficit would tend to cause lower interest rates in the short term.

The longer-term effects were less certain, but

changes in the deficit should have long-lasting effects on interest rates in that they altered Investors’ expectations of future inflation and perceptions of the long-term growth potential of the economy. Interest rate reductions would thus be larger if deficit cuts were seen to reflect a major change in fiscal policy toward greater efficiency in the public sector, and a more

sustainable fiscal position over the longer term. The bank emphasised the importance of expectations in this process, and said interest rates might fall before the size of the deficit was actually reduced if the policy was seen as being credible, and as offering the potential for significant future gains. ' Relaxing the monetary policy stance did not offer the same chance of reducing interest rates. New Zealand's inflation rate was still significantly above the rates of its main trading partners, and it did not yet have a long track record of operating a firm non-inflation-ary monetary policy. , In these circumstances, there would be a high risk that easing the monetary policy stance could quickly lead to a rise In Inflationary expectations and therefore higher nominal interest rates, the bank said. The article also discussed the links between domestic interest rates and the exchange rate.