Why keep long rates low?

Bank economists are saying that we should aim to keep “long-term” rates low – through the RBNZ committing to a future path of the OCR for the next 3-5 years at a low rate.

At first brush we could be cynical and say this appears to be in their interest – the OCR does determine their cost of borrowing from the RBNZ after all.  But I am not that cynical about the bank economists.  Ultimately when you look at their beliefs, the commitment to a low OCR makes sense.  They believe:

• Growth and “capacity” will remain well below trend for the medium term.  Specifically – we will be below our “natural rate of output”.  This implies that we don’t have to worry about inflationary pressures (until we are heading back to the natural rate).
• Short rates have already headed nearly as low as they can go – so they can’t be cut much further.
• The RBNZ’s growth path is “too strong” – and so the market expects rates to begin rising in 2010.
• If medium term rates are higher this provides a disincentive to investment – something that depresses near term activity further, thereby increasing the risk of some sort of “downward spiral” through unemployment.

So ultimately, the retail banks are saying that the RBNZ is too optimistic (as if they weren’t their implicit forecasts would commit a lower medium term set of rates).  I guess we will see what the RBNZ does on Thursday and find out if they agree …