17 September 2002
The Finance Minister and the incoming Governor of the Reserve Bank today signed a new Policy Targets Agreement (PTA), which sets out specific targets for achieving and maintaining price stability.
The most significant change is that the Reserve Bank is required to take a forward looking, medium-term approach to achieving price stability. This gives the Bank more flexibility to decide how it responds to shocks in the economy and inflation variations around the target.
The new PTA raises the bottom of the inflation target to 1 per cent, while retaining the 3 per cent upper limit and includes a statement of the Government's broader economic goals.
Dr Cullen said: "The Government's aim has always been to avoid unnecessary instability in output, interest rates and the exchange rate. That objective was explicitly included in the PTA I signed in 1999 with the previous governor. I believe the changes inserted in this PTA will make it easier for the bank to achieve this goal.
"The agreement is broadly as the markets have been anticipating and is consistent with the publicly stated advice of expert commentators. I expect it to be well-received by the financial markets and by other stakeholders in the economy."
Dr Bollard said: "This PTA acknowledges the way monetary policy has and will evolve. As inflation expectations have become steadily better anchored, so monetary policy has become more flexible, and this trend will continue, as signalled in this PTA.
"Price stability is the Reserve Bank's `primary function', but we also seek to avoid `unnecessary instability in output, interest rates and the exchange rate.' The shift to an inflation target `on average over the medium term' allows us to better achieve this. This helps economic growth, which, we all agree, New Zealand needs, by enhancing predictability and confidence and, by that, savings and productive investment. The raising of the bottom of the band brings the overall target more in line with New Zealand's inflation outcomes in recent years and those in other countries.
"In addition, today I am releasing the text of a letter that I intend to send to the Minister once I have begun my duties as Governor. This lays out how I wish to manage my relationship with the Minister, recognising the particular need for the Bank to be operationally independent and yet also for the Bank and the Government to keep each other informed," Dr Bollard concluded.
Dr Cullen added that the new PTA sits well alongside the framework for the improved accountability mechanisms recommended by the Svensson Review and legislated for in the Reserve Bank Amendment Bill currently before Parliament. The bill strengthens the Reserve Bank Board's role within the Bank and enhances the Bank's independence.
The bill retains the Governor as a member of the Board but removes him as chairman in favour of a non-executive chair, and requires that the Board issue its own annual report assessing the performance of the Governor.
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The new Policy Targets Agreement is attached, plus the text of the letter referred to. The letter will be signed when Dr Bollard formally takes up his appointment on 23 September.
This agreement between the Minister of Finance and the Governor of the Reserve Bank of New Zealand (the Bank) is made under section 9 of the Reserve Bank of New Zealand Act 1989 (the Act). The Minister and the Governor agree as follows:
1. Price stability
a) Under Section 8 of the Act the Reserve Bank is required to conduct monetary policy with the goal of maintaining a stable general level of prices
b) The objective of the Government's economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.
2. Policy target
a) In pursuing the objective of a stable general level of prices, the Bank shall monitor prices as measured by a range of price indices. The price stability target will be defined in terms of the All Groups Consumers Price Index (CPI), as published by Statistics New Zealand.
b) For the purpose of this agreement, the policy target shall be to keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term.
3. Inflation variations around target
a) For a variety of reasons, the actual annual rate of CPI inflation will vary around the medium-term trend of inflation, which is the focus of the policy target. Amongst these reasons, there is a range of events whose impact would normally be temporary. Such events include, for example, shifts in the aggregate price level as a result of exceptional movements in the prices of commodities traded in world markets, changes in indirect taxes, significant government policy changes that directly affect prices, or a natural disaster affecting a major part of the economy.
b) When disturbances of the kind described in clause 3(a) arise, the Bank will respond consistent with meeting its medium-term target.
4. Communication, implementation and accountability
a) On occasions when the annual rate of inflation is outside the medium-term target range, or when such occasions are projected, the Bank shall explain in Policy Statements made under section 15 of the Act why such outcomes have occurred, or are projected to occur, and what measures it has taken, or proposes to take, to ensure that inflation outcomes remain consistent with the medium-term target.
b) In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner and shall seek to avoid unnecessary instability in output, interest rates and the exchange rate.
c) The Bank shall be fully accountable for its judgements and actions in implementing monetary policy.
Hon Dr Michael Cullen
Dr Alan E Bollard
Minister of Finance
Reserve Bank of New Zealand
Dated at Wellington this 17th day of September 2002
Hon Dr Michael Cullen
On assuming the responsibility as Governor of the Reserve Bank I thought it would be useful to outline how I envisage various important relationships evolving.
To contribute to the effective conduct of overall economic policy it would be useful to build on the existing relationship between the Reserve Bank and The Treasury in sharing information. In addition I would like to establish a regular dialogue with you on economic developments and ensure that I remain fully briefed on the development of Government policies which potentially impact on the formulation and implementation of monetary policy consistent with the Policy Targets Agreement. It is also important to ensure that there is a shared understanding of the way in which the Policy Targets Agreement impacts on the formation and implementation of monetary policy.
It is both my obligation and intention to consult with a wide range of sources in the public and private sectors in forming my opinion as to the appropriate monetary conditions consistent with maintaining stability in the general level of prices.
The Reserve Bank also has a broader range of operational and policy functions. To the extent you have a responsibility in these areas, the Bank will provide timely briefings and reports on matters of importance to you.
I believe that we should agree that we should inform each other of the release of material into the public domain that may be likely to cause public comment on matters of mutual interest. We should take care to ensure such material is not inconsistent with maintaining the independence and credibility of the Bank.
Dr Alan E Bollard
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