inflation targeting: the new zealand experience
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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 - PowerPoint PPT PresentationTRANSCRIPT
Inflation Targeting:The New Zealand experience
Banco Central do Brasil11 August 2006
Grant SpencerAssistant 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• Defining medium term inflation objective• Influence of global interest rates
• Points for discussion
Inflation targeting has been good for New Zealand
• Lower and more stable inflation
• Higher and more stable output
06040200989694929088868482807876
20
15
10
5
0
20
15
10
5
0
Ann % Ann %
Inflation
Pre-inflation targeting (1975 – 1990)Average inflation = 12.4%Standard deviation = 4.6%
06040200989694929088868482807876
20
15
10
5
0
20
15
10
5
0
Ann % Ann %
Inflation
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%
06040200989694929088868482807876
10
5
0
-5
-10
10
5
0
-5
-10
Ann % Ann %
Annual GDP Growth
Post price stability(1992 – 2006)
Average GDP Growth = 3.4%Standard deviation = 2.0%
06040200989694929088868482807876
10
5
0
-5
-10
10
5
0
-5
-10
Ann % Ann %
Annual GDP Growth
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
• 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
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 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
Minister of Finance
Board of Directors
Governor
Reserve Bank
•Policy Targets Agreement
•5 yr funding agreement
•Board reports on Bank performance
•Board monitors Bank performance
Public/markets
Parliament
•Qtrly Monetary Policy statements
•Annual report•Committee hearings
•Monetary policy decision maker
200620042002200019981996199419921990
8
7
6
5
4
3
2
1
0
8
7
6
5
4
3
2
1
0
Ann % Ann %
Inflation
200620042002200019981996199419921990
8
7
6
5
4
3
2
1
0
8
7
6
5
4
3
2
1
0
Ann % Ann %
Inflation
Evolution of the PTA
200620042002200019981996199419921990
8
7
6
5
4
3
2
1
0
8
7
6
5
4
3
2
1
0
Ann % Ann %
Inflation
• 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
20052000199519901985198019751970
100
80
60
40
20
0
200
150
100
50
0
USD NZD
Nominal USD oil price (LHS)
Real oil price, 2006 New Zealand Dollars (RHS)
Monetary policy looks through supply shock but expectations influenced by headline inflation
060402009896
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
Ann % Ann %
Inflation
Inflation Expectations
Issue 1
2007200520032001199919971995
5
4
3
2
1
0
5
4
3
2
1
0
% %
Target range
Central projectionProjection
CPI inflationCPI inflation expected to be
outside target range for 8 qtrs
Issue 2Current policy Issues in NZ: 2. What do we mean by “on average over the medium term”
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
Issue 2
• A more explicit definition of the medium term may be necessary to enderpin policy credibility
Current policy Issues in NZ: 3. The impact of recent OCR increases has been weakened by low global interest rates
4
5
6
7
8
9
1999 2000 2001 2002 2003 2004 2005 2006
Percent
Official Cash Rate (OCR)
Effective mortgage rate
+225 basis points
+95 basis points
Issue 3
Policy has been aimed at moderating housing and domestic demand pressures
Issue 3
060402009896
10
8
6
4
2
0
30
25
20
15
10
5
0
-5
Ann % Ann %
Private Consumption
House price inflation
But borrowers have moved increasingly to fixed rate borrowing, funded offshore
0
20
40
60
80
100
120
1999 2000 2001 2002 2003 2004 2005 2006
Floating Fixed
NZ$ billion
Issue 3
But borrowers have moved increasingly to fixed rate borrowing, funded offshore
0
20
40
60
80
100
120
1999 2000 2001 2002 2003 2004 2005 2006
Floating Fixed
NZ$ billion
Issue 3
At the same time, higher short rates have put pressure on the exchange rate
2005200320011999
6
4
2
0
-2
75
70
65
60
55
50
45
% Index
90 day rate spread(NZ-US)
TWI (RHS)
Issue 3
At the same time, higher short rates have put pressure on the exchange rate
2005200320011999
6
4
2
0
-2
75
70
65
60
55
50
45
% Index
90 day rate spread(NZ-US)
TWI (RHS)
Issue 3
Causing demand to be spilled into imports, worsening the balance of payments
Issue 3
20062005200420032002200120001999
-2
-3
-4
-5
-6
-7
-8
-9
-10
52
48
44
40
36
32
28
24
20
16
12
8
% of GDP NZ$bill
Current Account Deficit (LHS)
Outstanding NZ dollar bondsissued offshore (RHS)
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
Issue 3
Points for discussion
• 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
Monetary policy has poor leverage when it is out of synch with global interest rates
Easy Tight
Easy
Tight
O’seas policy
NZ policy
Predominant effect of NZ policy change
• Int rate• Ex rate
• Int rate
• Int rate • Ex rate
Policies in synch
Issue 3
Role of the exchange rate in monetary policy has changed markedly over the 20 years since the float
Evolution of monetary policy regime
•Disinflation period•Uncertain inflation expectations and real interest rate
•Initial float period
•Mgmt of interest and exch rate•Reducing pass through
•Inflation targeting through OCR and Qgap•Medium term target
40
60
80
100
Mar-80 Mar-85 Mar-90 Mar-95 Mar-00
index
-5
0
5
10
15
20%
Crawling Peg
Exchange Rate Comfort Zone
Check List OCR
Direct Controls
<------------- Floating Exchange Rate ------------>
TWI
inflation (right scale)
MCI
6
7
8
9
10
1999 2000 2001 2002 2003 2004 2005 2006
Percent
Two year fixed mortgage rate
Fixed rates have been more attractive than floating mortgage rates
Fixed rates have been more attractive than floating mortgage rates
6
7
8
9
10
1999 2000 2001 2002 2003 2004 2005 2006
Percent
Floating mortgage
rate
Two year fixed mortgage rate
Fiscal performance has improved markedly
2005200019951990
6
5
4
2
1
-0
-2
-3
-4
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
% of GDP % points
Fiscal Balance (LHS)
NZ-US 10yr Bond Spread(RHS)
Commodity prices are an important driver of exchange rate cycles
20052000199519901985
160
150
140
130
120
110
100
90
80
78
75
72
69
66
63
60
57
54
51
48
45
Index Index
Commodity Prices (LHS)
Trade Weighted Index (RHS)
Exchange rate cycles are led by the housing cycle
20052000199519901985
30
25
20
15
10
5
0
-5
-10
78
75
72
69
66
63
60
57
54
51
48
45
Ann % Index
House Price Inflation (LHS)
Trade Weighted Index (RHS)
Preconditions for IT
"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)