NEW ZEALAND and INFLATION TRAGETING

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NEW ZEALANDand INFLATION TRAGETING
James Mitchell Aurash Alavi Kungzhow Young
Christine Le
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WHERE IS IT?
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New Zealand

• Population 4 million
• Major languages English, Maori
• NZ has 4 million people (14 per square km), 39.5
  million sheep (135 per square km) and 9 million
  cattle
  
• Around 80 of meat produced is exported NZ
  supplies 54 of world exports of sheep meat.
  
• NZ was the first western democracy to give women
  the vote
  
• New Zealand has won more Olympic gold medals, per
  capita, than any other country.

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New Zealand

• Capital Wellington
• Independence From the UK
• September 26, 1907
• Area 103,738 sq mi (about the size of
  Colorado)
  
• GDP (PPP) 2005 estimate
• - Total 101.685 billion USD (58th)
• - Per capita 24,797 USD (27th)
• HDI (2003) 0.933 (19th) high
• Labor force - by occupation
• agriculture 10
• industry 25
• services 65 (1995)
• Unemployment rate 4 (2005 est.)

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How is New Zealands Economy?
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Macroeconomic Overview

• New Zealand was a world leader in
• economic growth from 1940 to the 1970s
• By the early 1980s New Zealand faced a series of
  economic obstacles
  
• New Zealands real GDP has increased from 91.6
  billion to 133.8 billion New Zealand dollars
  since 1993
  
• GDP growth has outpaced population inflow,
  averaging 111.5 billion dollars over the past
  decade
  
• While per capita GDP continues to rise, it is
  among the lowest of the highly developed
  economies
  

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Central Bank of New Zealand

• The Reserve Bank was established in 1934 and is
  wholly government owned. Its current governance
  arrangements and institutional purpose are
  defined in the Reserve Bank of New Zealand Act
  1989.
• The Reserve Bank does not use committees,
  internal or external, to make formal decisions.
  The Bank has an extensive internal committee
  system which provides the Governor with detailed
  advice. However, under the Reserve Bank Act,
  authority is vested in the Governor, unlike many
  other central banks where decision-making
  authority is often vested with committees.

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Some more facts

• In mid-1984 New Zealand began a rapid process of
  economic deregulation and state sector reform. As
  part of this, a consensus emerged among
  policymakers that New Zealand needed to restore
  price stability.
• In part, this reflected a growing realization
  that attempting to use stimulatory monetary
  policy to deliver faster sustainable economic
  growth would not work.
• The dollar was floated in March 1985 and by
  ministerial direction monetary policy was
  switched to an exclusive focus on getting
  inflation down and then keeping it down.
• This priority was passed into law with the
  passage of the Reserve Bank of New Zealand Act
  1989, which established the framework within
  which the Reserve Bank operates today

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• Mishkin(1999) discussed four monetary policy
  regimes
  
• exchange rate targeting, e.g.
• monetary aggregate targeting, e.g., Germany
  before the European monetary union and
  Switzerland
  
• inflation targeting, e.g. New Zealand, UK,
  Canada
  
• an eclectic approach, e.g. US under Greenspan

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(No Transcript)
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INFALTION TARGETING
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Inflation Targeting

• Elements
• 1. Public announcement of medium-term
  inflation-target
  
• 2. Institutional commitment to price stability
• 3. Information inclusive strategy
• 4. Increased transparency through public
  communication
  
• 5. Increased accountability

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Target range

• Tradeoff between target accuracy vs. policy
  credibility and bias toward range ceiling
  
• Converging economies range targets adopted when
  uncertainty is large (Chile 1991-94 Israel
  1995-98 Brazil), point targets adopted when
  aiming at strengthened policy credibility and
  avoidance of ceiling bias (Chile 1995-00, Israel
  1999, Hungary 1998-00)
• Stationary economies range targets more
  frequent. All fall within 0-4 inflation
  interval.
  

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Inflation Targeting range
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List of countries adopting IT
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INFALTION TARGETINGinNEW ZEALAND
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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)
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Inflation Targeting in NZ

• New Zealand was the first country in the world to
  introduce an explicit target for inflation, after
  the Reserve Bank Act was passed in 1989. The Act
  also introduced an entirely new institutional
  framework for monetary policy.
• New Zealands central banking legislation, the
  Reserve Bank of New Zealand Act 1989, has
  attracted world-wide interest.
  
• Since 1989 many central banks around the world
  have joined the inflation targeting club, and
  none has left. There are more than 20 inflation
  targeting countries and the number is likely to
  increase

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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

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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
  

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Institutional structure of IT in NZ
Reserve Bank
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• 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
  

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Monetary policy
Issue 1
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Pre-inflation targeting (1975 1990)Average
inflation 12.4Standard deviation 4.6
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Post price stability(1992 2006)Average
inflation 2.2Standard deviation 0.7
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Pre-inflation targeting (1975 1990)Average GDP
Growth 1.5Standard deviation 2.8
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Post price stability(1992 2006)Average GDP
Growth 3.4Standard deviation 2.0
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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

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Inflation Targeting in New Zealand, Canada, and
the UK
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INFLATION TARGETING

• Advantages
• The ultimate goal of monetary policy is clearly
  stressed
  
• Transparent as inflation rate is known to the
  public
  
• Meeting the targets raises credibility, and
  stabilizes inflation expectations
  
• Inflation forecasts are based on a multitude of
  indicators (money and credit, interest rate
  spreads, business survey data, labor market
  conditions and wage rates, development in output
  markets), large information base

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INFLATION TARGETING

• Disadvantages
• Time lags of monetary policy impulses on
  inflation require relying on inflation forecasts
  
• These are conditional forecasts ? lack of
  transparency
  
• Forecasts are based on developments in the real
  economy
  
• Neglect of longer-run monetary developments and
  their impact on asset prices
  
• Transmission channels of monetary policy have to
  be known for inflation forecasting
  
• High inflation rates are generally associated
  with high levels of inflation variability such
  that inflation goals are missed frequently
  

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• Thank you!