2022 Monetary Policy Challenge
The Monetary Policy Challenge gives Year 12 and 13 students all over New Zealand the opportunity to address and engage with the monetary policy decisions facing the country.
Congratulations to James Hargest College as the national winner of the 2022 Monetary Policy Challenge.
Honourable mentions go to:
- Hutt Valley High School
- Rangitoto College
- Wellington Girls' College
- Westlake Boys' High School
Watch James Hargest College's winning entry:
This is most likely less than some would have expected as the last increase was by 50 basis points from 2.5% to 3%, however the smaller increase reflects the future focused nature of monetary policy rather than reacting to the current environment.
Inflation is currently far outside of the target band of 1 to 2% sitting at 7.3%, meaning an increase in the OCR is required to combat this.
Increasing the OCR will increase interest rates, slowing down growth in the economy and decreasing inflation by improving both customers and demand for inflation. The slowing of growth will also be conducive to bringing the economy back to maximum sustainable employment.
Aggregate demand is determined by consumption spending, investment spending, government spending and net exports. Aggregate supply is determined by cost factors such as the cost pressures for producers and capacity constraints.
As shown in the graph, AS has shifted back for a number of reasons, creating cost push inflation. Factors leading to this are constraints on capacity, a tight labour market, supply chain shortages and wage inflation. This is particularly worrying as wage inflation can push prices up leading to a wage price inflation spiral.
However, we believe this will improve in the future with borders opening up after COVID-19 and international travel becoming less risky, immigrants are more able to come and work in New Zealand and with new immigration regulations to target worker shortages, we expect the labour market to begin returning to the maximum sustainable employment, improving output capacity and wage inflation which will decrease costs for businesses, meaning we expect to see AS shifting forward in the future.
Also business confidence is low. Many businesses have built interest rate increases into the expectations, making them weary of investment spending which is needed to ensure future output capacity is not limited by lack of investment spending.
This is why we have decided to increase the OCR by just 25 basis points because many of the inflationary pressures on AS are short-term and due to the low business confidence.
Aggregate demand has shift would help for a number of reasons. Firstly although we see consumer spending is increasing, we expect this to decrease in the future and this is due to consumer confidence decreases since 2020 because of inflationary expectations, household debt, increasing house prices and increasing mortgage rates.
The second component of aggregate demand is government spending. Government spending has been very high recently and this is due to the government's COVID response, infrastructure programs and cost of living payments which have all been inflationary.
They are currently cutting spending to decrease their debt and return to a surplus and as shown in the graph, they would like the operating balance to return to a surplus after the gains and losses from in the 2024 and 2025 years.
The second component of aggregate demand is investment spending. As stated earlier in the AS section, business confidence is quite low at the moment meaning that there is currently and likely to be a future decrease in investment spending.
Another reason why we can't expect aggregate demand to potentially decrease in the future, meaning a smaller increase in the OCR is required.
So in terms of new exports, we see that the terms of trade is expected to have a modest decline and this is mainly due to external factors such as lockdowns in China as well as increasing interest rates in the US.
We will currently have a very strong dairy payout and this is a result of depreciation of the New Zealand dollar right now, which is really helping to maintain the terms of trade.
Secondly in terms of tourism — tourism used to be our main export pre-COVID, so if we see that the number of visitors is expected to surge after borders being reopened, this will definitely further increase our export receipts very significantly.
Just to sum up, we have a couple of main inflationary factors currently. First, we have a very tight labour market — this leads to rage inflation and constraints on output as stated before.
Secondly, we have very high government spending as well as high level of consumer spending as well, and these both increase aggregate demand causing demand for inflation.
Lastly, we have a depreciating New Zealand dollar which leads to increased export receipts and more expensive Imports. Most of these factors are not long-term, mainly short-term particularly the labour market as well as government spending. We are going to keep increasing the OCR until inflation is under control, but there is opportunity right now to kind of pull back a little bit, so that people can get used to it and manage with the increase in interest rates.
We do have to be careful that we're not overreacting since the increases may be difficult for low budget households and businesses. Now with this decision, there is a few risks involved.
Firstly is the inflationary expectations from businesses and consumers as stated before. Secondly, if we aren't able to attract workers overseas to come into New Zealand, we will continue to have supply side issues.
Despite all these risks, increasing the OCR by 25 basis points from 3% to 3.25% at the Monetary Policy Review in October would be the best choice.
Webinar for students
Chief Economist Paul Conway, Advisor Evelyn Truong, and Market Analyst Brandon Kengmana were on the panel for the 2022 Monetary Policy Challenge Webinar. They discussed the August Monetary Policy Statement, what it’s like working in economics and answered a range of students questions. Watch the full webinar below.
If you were members of the Monetary Policy Committee what would you set the OCR to at the Monetary Policy Review (MPR) in October?
In your response, consider what your central expectation/forecast is for inflation and employment in the medium term (next 18 to 24 months). You should comment on the main factors that affect your outlook for inflation and employment and how you balance the competing pressures to form your central expectation. You should also comment on some important risks that could change your outlook for inflation and/or employment if those risks materialised and what they would do to the OCR.
You may find reading the most recent Monetary Policy Statement and the Monetary Policy Handbook helpful in forming your answer.
August 2022 Monetary Policy Statement
Monetary Policy Handbook