Our economic model explained
The Reserve Bank’s economic model is intended to illustrate how our economy works and provide a framework for the Bank’s economists to think about what is happening within it and where the economy, and inflation, may be heading next. It shows the total amount of goods and services produced in our economy, or our Gross Domestic Product.
Economists feed data and other information into the model and then use their economic judgement and experience to consider how different parts of the economy might be affected in various scenarios. For example, if households start saving more, or businesses start investing less.
The information it produces feeds into the Bank’s economic forecasts and monetary policy decisions. It is also used in carrying out research.
The monetary policy dial is our tool for affecting the cost of borrowing money in New Zealand. We turn this up or down to:
- change interest rates
- help keep prices within the economy stable
- keep employment near the maximum sustainable level.
*This is a simplified and stylised depiction of the Reserve Bank’s economic model. It is not a fully accurate representation of the elements and connections included in the model.
Economic model
Household spending
What if consumers become nervous about economic developments happening in Europe or the US? What would it mean for our economy?
What if consumers find the value of their homes has increased – how might that affect their spending habits?
Households
What happens if mortgage costs increase – how might households change their behaviour because of this? And what if house prices were to plummet, what would this mean for the economy?
Banks
What’s happening with floating and fixed mortgage rates? What’s happening with bank lending to the business sector, to the rural sector? How easy is it for banks to borrow funds from the rest of the world?
Investment
If businesses are nervous that interest rates could go up in the near future and therefore the cost of borrowing money increases, how much is that likely to affect whether they take on more staff, or grow their businesses?
Foreign goods and services (tradeable output)
Our economy also produces and consumes goods and services from the rest of the world. This includes things like buying things online from overseas and tourists spending their money in New Zealand. International transactions affect our current account (our transactions with the rest of the world). Important questions in this area include – are we earning enough in foreign currency to pay for the foreign goods we as a country buy? Which products and which countries do we export to? Which countries and which products do we import from?
Government spending
How would the economy be affected if the Government started spending more? Or if the Government decreased or increased taxes?
Local goods and services (non-tradeable output)
How would our economy be affected if less people started going to University, the cost of medicines increased dramatically, or if people stopped shopping in stores and bought more online?
Reserve Bank of New Zealand
How fast is the economy likely to grow over the near future? Is employment at its maximum sustainable level? Are inflation pressures rising or falling? How would these outlooks change if we were to change our monetary policy settings, and thereby the cost of borrowing money?
Businesses
Should I increase or decrease production? How? By hiring more staff, or investing in more plant and machinery?
Should I change my prices? What will happen to demand, revenue, profits?
Exports
What would happen if the amount of dairy products we export increased or decreased sharply due to poor weather conditions? What would that mean for our economy?
How does the outlook for the Chinese economy affect international dairy prices and our terms of trade?
Imports
What if the price of imported goods dropped significantly – how might that affect the companies in New Zealand that make goods we can also buy from overseas, and what impact would that have on our economy?
Loans from the rest of the world
How would our economy be affected if our external debt (the amount of money the country as a whole owes to lenders overseas) became especially large?
The New Zealand Dollar
What caused the NZ dollar to move? Was it related to something happening in the rest of the world, or something that happened in NZ? How does the change in the NZ dollar affect the export sector? What is the impact on prices and inflation?
The monetary policy dial
So where do we think the economy might be in 1 or 2 years' time, and which way, and how much should we change our monetary policy tools to influence interests rate and to manage inflation and support maximum sustainable employment in NZ?