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Inflation Targeting: The New Zealand experience. Banco Central do Brasil 11 August 2006 Gra nt Spencer Assistant Governor Reserve Bank of New Zealand. Contents. History of IT in NZ Characteristics of the NZ approach Evolution of IT in NZ Current issues Impact of oil shock

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Inflation targeting the new zealand experience

Inflation Targeting:The New Zealand experience

Banco Central do Brasil

11 August 2006

Grant Spencer

Assistant Governor

Reserve Bank of New Zealand


Contents
Contents

  • History of IT in NZ

  • Characteristics of the NZ approach

  • Evolution of IT in NZ

  • Current issues

    • Impact of oil shock

    • Defining medium term inflation objective

    • Influence of global interest rates

  • Points for discussion


Inflation targeting has been good for new zealand
Inflation targeting has been good for New Zealand

  • Lower and more stable inflation

  • Higher and more stable output


Pre inflation targeting 1975 1990 average inflation 12 4 standard deviation 4 6
Pre-inflation targeting (1975 – 1990)Average inflation = 12.4%Standard deviation = 4.6%


Post price stability 1992 2006 average inflation 2 2 standard deviation 0 7
Post price stability(1992 – 2006)Average inflation = 2.2%Standard deviation = 0.7%


Pre inflation targeting 1975 1990 average gdp growth 1 5 standard deviation 2 8
Pre-inflation targeting(1975 – 1990)Average GDP Growth = 1.5%Standard deviation = 2.8%


Post price stability 1992 2006 average gdp growth 3 4 standard deviation 2 0
Post price stability(1992 – 2006)Average GDP Growth = 3.4%Standard deviation = 2.0%


But inflation targeting was part of a wider economic reform program in the late 1980s early 1990s
But Inflation targeting was part of a wider economic reform program in the late 1980s – early 1990s

  • Inflation targeting – Reserve Bank Act (1989)

  • Financial sector liberalisation (1984-1985)

  • Fiscal reform – Fiscal Responsibility Act (1994)

  • Reform of broader public sector management – State Sector Act(1988), State Owned Enterprises Act(1986)

  • Labour market reform – Employment Contracts Act (1991)

  • Privatisation of state trading enterprises – eg Telecoms, Energy

  • Trade liberalisation


Key influences behind it in nz
Key influences behind IT in NZ program in the late 1980s – early 1990s

  • Broader public sector reforms in late 1980’s were consistent with giving RBNZ a single clear objective – and accountability

  • Financial liberalisation and the float of the NZ dollar in the mid 1980’s gave the Bank the ability to run an effective market based monetary policy

  • Monetary theory (Monetarism, the NRH, Rational Expectations) pointed to inflation as the appropriate single objective for monetary policy

  • Money and credit aggregates had proven ineffective as intermediate targets for monetary policy


Institutional characteristics of the nz approach
Institutional characteristics of the program in the late 1980s – early 1990sNZ approach

  • Standard characteristics

  • An independent Central Bank (Reserve Bank Act 1989)

    • 5 year term for Governor

    • 5 year funding agreement with Government

  • Explicit inflation target

    • Price stability the legislated goal for Monetary Policy

    • Inflation target specified in contract between Minister and Governor (PTA)

  • Accountability structures

    • Board monitors performance of Governor - continuous

    • Parliament – annual report and quarterly reviews of policy statements

    • Markets and public – quarterly policy statements


Institutional characteristics of the nz approach1
Institutional characteristics of the program in the late 1980s – early 1990sNZ approach

  • Non standard characteristics

  • Single decision maker – the Governor

    • Advice from internal advisory group of governors and senior staff – not the Board

  • Role of Board is purely monitoring

    • Can recommend dismissal of governor for non-performance

  • High level of forecast disclosure

    • Detailed quarterly forecasts including interest and exchange rate forecasts


Institutional structure of it in nz
Institutional structure of IT in NZ program in the late 1980s – early 1990s

Board of

Directors

Minister of

Finance

  • Board reports on Bank performance

  • Policy Targets Agreement

  • 5 yr funding agreement

  • Board monitors Bank performance

Governor

  • Monetary policy decision maker

Reserve Bank

Parliament

Public/

markets

  • Annual report

  • Committee hearings

  • Qtrly Monetary Policy statements


Evolution of the pta
Evolution of the PTA program in the late 1980s – early 1990s

  • Strict IT

  • Target 0% - 2%

  • Caveats for shocks

  • Short policy horizon

  • Policy emphasis on exch rate rather interest rates

  • Flexible IT

  • Target 0% - 3%

  • No explicit caveats

  • Policy emphasis shifting from exch rate to interest rate

  • Target 1% - 3%

  • On average over medium term

  • Avoid unnecessary volatility in output, exch rate, int rate


Current policy issues in nz 1 how to contain the second round effects of the oil shock

Issue 1 program in the late 1980s – early 1990s

Current policy Issues in NZ: 1. How to contain the second round effects of the oil shock?


Monetary policy looks through supply shock but expectations influenced by headline inflation

Issue 1 program in the late 1980s – early 1990s

Monetary policy looks through supply shock but expectations influenced by headline inflation


Current policy issues in nz 2 what do we mean by on average over the medium term

Issue 2 program in the late 1980s – early 1990s

Current policy Issues in NZ: 2. What do we mean by “on average over the medium term”

CPI inflation expected to be

outside target range for 8 qtrs

CPI inflation


Achieving the target on average over the medium term can be defined in various ways

Issue 2 program in the late 1980s – early 1990s

Achieving the target “on average over the medium term” can be defined in various ways:

  • For example:

  • Three year forward moving average of CPI inflation projections

  • Three year backward or centered moving average of actual and projected CPI inflation

  • Being comfortably within the target zone in the second half of a three year ahead horizon

  • A more explicit definition of the medium term may be necessary to enderpin policy credibility


Issue 3 program in the late 1980s – early 1990s

Current policy Issues in NZ: 3. The impact of recent OCR increases has been weakened by low global interest rates


Policy has been aimed at moderating housing and domestic demand pressures

Issue 3 program in the late 1980s – early 1990s

Policy has been aimed at moderating housing and domestic demand pressures


But borrowers have moved increasingly to fixed rate borrowing funded offshore

Issue 3 program in the late 1980s – early 1990s

But borrowers have moved increasingly to fixed rate borrowing, funded offshore


But borrowers have moved increasingly to fixed rate borrowing funded offshore1

Issue 3 program in the late 1980s – early 1990s

But borrowers have moved increasingly to fixed rate borrowing, funded offshore


At the same time higher short rates have put pressure on the exchange rate

Issue 3 program in the late 1980s – early 1990s

At the same time, higher short rates have put pressure on the exchange rate


At the same time higher short rates have put pressure on the exchange rate1

Issue 3 program in the late 1980s – early 1990s

At the same time, higher short rates have put pressure on the exchange rate


Causing demand to be spilled into imports worsening the balance of payments

Issue 3 program in the late 1980s – early 1990s

Causing demand to be spilled into imports, worsening the balance of payments


This issue has led to a search for supplementary stabilisation instruments

Issue 3 program in the late 1980s – early 1990s

This issue has led to a search for supplementary stabilisation instruments

  • Examples:

  • Changes to the tax system that might moderate the amplitude of housing cycles

  • Structural policies aimed at improving supply responses in housing booms

  • Enhancements to the banking supervision framework to reduce any amplifier effect of bank lending on the housing cycle

  • Other discretionary cyclical stabilisation instruments


Points for discussion
Points for discussion program in the late 1980s – early 1990s

  • Are institutional arrangements working properly?

    • Decision making

    • Formal monitoring structures

    • Policy transparency and effective market monitoring

  • How to minimise the impact of the current oil shock on inflation expectations?

  • How to maximise policy credibility under a flexible IT regime?

  • How to manage policy when the domestic cycle is out of synch with the global cycle?


End program in the late 1980s – early 1990s


Monetary policy has poor leverage when it is out of synch with global interest rates

Policies in synch program in the late 1980s – early 1990s

Predominant effect of NZ policy change

O’seas policy

Issue 3

  • Int rate

  • Ex rate

  • Int rate

Tight

Easy

  • Ex rate

  • Int rate

NZ policy

Easy

Tight

Monetary policy has poor leverage when it is out of synch with global interest rates


Role of the exchange rate in monetary policy has changed markedly over the 20 years since the float
Role of the exchange rate in monetary policy has changed markedly over the 20 years since the float

Evolution of monetary policy regime

  • Initial float period

  • Disinflation period

  • Uncertain inflation expectations and real interest rate

  • Mgmt of interest and exch rate

  • Reducing pass through

  • Inflation targeting through OCR and Qgap

  • Medium term target







Preconditions for it
Preconditions for IT cycles

"it is sometimes suggested that inflation targeting … requires a sophisticated inflation forecasting ability in the central bank, or a sophisticated financial system, or a sophisticated measure of inflation… But when New Zealand began inflation targeting in the eighties, we had none of those things...“

(Don Brash, Governor 1988-2002)


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