Today’s infrastructure announcements from the government should provide a welcome boost for the economy, even though the $500 million spend is hardly earth shattering.

But too much stimulus - and it is not difficult to have too much – and ministers risk an inflationary surge and large interest rate hikes just as they head into the next election.

Today’s announcement focuses on spending on roads, housing and schools.

Most, if not all of the work, has already been planned and it appears the announcement, being made by Prime Minister John Key and Finance Minister Bill English, will simply be bringing them forward.

There is already a fair surge of stimulation working its way through the New Zealand economy.

On the monetary side, the Reserve Bank has more than halved interest rates over the past six months and will continue cutting for until April or maybe even June.

The official cash rate was 8.25% just over six months ago: it is now 3.5% and likely to go to 2%.

It is very important to remember interest rate changes have a lag effect of 12 to 18 months before they fully work their way through the economic system.

To some extent this stimulus is offset by the other side of the monetary policy ledger – the exchange rate. This has fallen more than 25c against the US dollar since the middle of the year and is likely to continue to do so.

That should start making imports more expensive but imports that are essential –especially fuel and products made from petroleum products – will still have to be paid for. That is not stimulatory but it is certainly inflationary.

Finally, of course, there are tax cuts. The first round was prised out of Michael Cullen’s trembling and resentful hands last October: a second batch begins on April 1, with more in April 2010 and 2011.

The backdrop to all this is the Budget.

And for political reasons, the Budget cannot be a damp squib. It can’t be too stimulatory, either. One of the reasons Standard & Poor's put New Zealand on credit watch four weeks ago was concerns of too much relaxation of the Crown accounts.

A credit rating downgrade is not just some pointy-headed economic exercise.

It will affect what interest rates New Zealand pays to borrow overseas – and since, at any one time, at least 40% of New Zealand’s bank borrowing is sourced overseas we need to be concerned about this.

And it is why, for example, ANZ National Bank chief economist Cameron Bagrie has said that “the ball is very much in Bill English’s court.”

Why is too much stimulus bad?

In a word, inflation. Since the great freeing up of the New Zealand economy between 1984-92, the New Zealand economy has come through two recessions and in both cases it has emerged far more quickly and with greater velocity than anyone has anticipated.

Indeed, even in New Zealand’s more controlled era, the economic bounceback from recessions in, for example, 1957-58 and 1967-68 were far more dramatic than was expected at the time.

We are a small economy, which can swing around very quickly.
And we have seen an inflationary surge.

If the interest rate stimulus is still working through, and if the government is still piling on spending increases to go with the already planned tax cuts, New Zealand could see an unpleasantly over-stimulated economy coming out of the current downturn.

Which could in turn see Reserve Bank governor Alan Bollard put up interest rates almost as drastically as he is now cutting them.

The timing of any recovery is never easy to predict but there is a fair chance of it being around two years or so away.

An inflationary surge and interest rate hikes, just as the election looms, is obviously not something ministers would want.

Today’s announcement should not be a total washout. But it would be better if there is not too much to get excited about.