28 October 1999
Minor technical change to inflation target
(Joint news release from The Treasurer and the Governor of the Reserve Bank)
A minor technical change to the way the Reserve Bank's inflation target is measured has been announced by Treasurer Bill English and Reserve Bank Governor Don Brash.
As of today, and as allowed for in the existing Policy Targets Agreement, the Reserve Bank's 0 to 3 per cent inflation target is to be calculated in terms of the Consumers Price Index (CPI), instead of the earlier underlying inflation and more recent CPIX inflation.
This change has occurred because the CPI itself has recently been changed by Statistics New Zealand, and it is now formatted in a way that is suitable as an inflation target.
The next CPI announcement is on 29 October, and for the first time interest rates will not be in the CPI. Previously the Reserve Bank had to target CPI inflation with interest rates removed (CPIX). That was because when the Reserve Bank increased interest rates to constrain increased inflationary pressures, CPI inflation went up. If unmodified CPI inflation had been the Reserve Bank's inflation target then, perversely, this would have demanded a further interest rate increase, like a cat endlessly chasing its tail, hence the CPIX target. With interest rates now out of the CPI, this problem is solved.
Treasurer Bill English said he welcomed the change. "The distinction between CPI and underlying or CPIX inflation has been confusing. We saw this recently when we had CPI deflation and CPIX inflation well within the 0 to 3 per cent inflation target. This change will remove this source of confusion," he said.
Reserve Bank Governor Don Brash said: "This change will have no effect at all on the stance of monetary policy. For financial markets its significance is zero. However, for the public's understanding of how monetary policy works this is a great step forward. As of today, the Reserve Bank's communications task has been made easier."
The new CPI also sees the deletion of section prices, which means that the inflation result to be announced on the 29th will not be strictly comparable with previous CPIX results. However, the difference is not significant for calculating annual inflation rates.
For background, attached please find a letter from the Reserve Bank to the Treasurer discussing these changes.
For further information contact:
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Paul Jackman |
Liz Rowe |
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Corporate Affairs Manager |
Press Secretary |
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Reserve Bank |
The Treasurer |
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Phone 04 471 3671, a/h 04 938 8177 |
Phone 04 471 9154, a/h 04 383 5491 |
22 October 1999
The Hon Bill English
The Treasurer
Parliament Buildings
Private Bag
WELLINGTON
Dear Treasurer
The current Policy Targets Agreement, signed by the Treasurer and me on my re-appointment as Governor on 15 December 1997 pursuant to section 9(1) of the Reserve Bank of New Zealand Act 1989, specifies (in clause 2(a)) that "the price stability target will be defined in terms of the All Groups Consumers Price Index excluding Credit Services (CPIX), as published by Statistics New Zealand".
Clause 2(c) of that Policy Targets Agreement notes that "notwithstanding clause 2(a), the Treasurer and the Governor may agree to use an alternative index of consumer price inflation following the implementation of the changes to the calculation of consumer prices proposed by the Government Statistician to take effect during 1999". This sub-clause was included in the Policy Targets Agreement because both parties were aware of the Government Statistician's intention to amend the Consumers Price Index during 1999 to exclude several items which, from a monetary policy point of view, would make that index a more appropriate measure of inflation.
The new Consumers Price Index will be published by the Government Statistician for the first time on 29 October 1999, covering the increase in prices between the June quarter of 1999 and the September quarter of 1999. The new index will update a number of the weights in the index, and will, importantly, remove interest rates and section prices from the index completely. The removal of interest rates makes the new index more similar to the CPIX index which is the focus of the existing Policy Targets Agreement, while the removal of section prices removes an asset price from the index which, in the Bank's view, is a desirable improvement in the index. (We have also argued for the exclusion of new house prices and the inclusion of imputed rentals instead, but at this stage the Government Statistician has not agreed to do this.)
I recommend that we agree that, with immediate effect, the price stability target in the Policy Targets Agreement be defined in terms of the new Consumers Price Index.
Because the Government Statistician will not be restating consumer price inflation in terms of the new index for any periods prior to the June quarter of 1999, the introduction of the new index raises a question about how best to calculate the "12-monthly increases" which, according to clause 2(b) of the Policy Targets Agreement, should be kept within a range of 0 to 3 per cent.
There is no perfect way of resolving this problem, but I recommend that, until it is possible to use four quarters of the new Consumers Price Index to calculate a "12-monthly increase" (in July 2000 for the year to the end of June 2000), we simply add the quarterly increases in the new Consumers Price Index to the quarterly increases in the old Consumers Price Index adjusted for the exclusion of interest rates and section prices. The two indices, even with the adjustments suggested, are not absolutely identical, so this is not a totally satisfactory solution. But I am advised that it is the best option available.
If you agree, I would be grateful if you would sign this letter indicating that agreement. We would propose to announce this minor technical change within the next few weeks, and in any case not later than the release of our next Monetary Policy Statement on 17 November 1999.
Yours sincerely
Don Brash
Governor
