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Forward guidance aids effective monetary policy

The Reserve Bank’s regular forward guidance on interest rates supports the effectiveness and accountability of its monetary policy actions, Assistant Governor and Head of Economics, Dr John McDermott, said today.

The Reserve Bank’s regular forward guidance on interest rates supports the effectiveness and accountability of its monetary policy actions, Assistant Governor and Head of Economics, Dr John McDermott, said today.

Speaking to the Goldman Sachs Annual Global Macro Conference 2016 in Sydney, Dr McDermott said that the Bank is very open about its monetary policy outlook. This includes the publication of a forward projection for the 90-day interest rate, comments on the outlook for policy, discussion of risks in its Monetary Policy Statements (MPS), and the presentation of alternative scenarios.

“The Bank is one of only a handful of central banks that publish forecasts for the short-term interest rate. This is a practice we have maintained since 1997.”

He said that the publication of the 90-day interest rate projection can improve the effectiveness of monetary policy in a number of ways. It can help individuals and businesses make more informed decisions. Second, the projection can help shift a broad range of interest rates towards levels consistent with medium-term price stability, improving the effectiveness of monetary policy.

“Third, the publication of the 90-day interest rate projection helps accountability,” Dr McDermott said.

Under the Policy Targets Agreement, the Bank is required to keep future average inflation close to the mid-point of the 1 to 3 percent target range, while avoiding unnecessary instability in output, interest rates and the exchange rate, and having regard for financial stability.

“This multitude of considerations influences the Bank’s judgement about how monetary policy should be adjusted to help move inflation towards its medium-term target.

“Every three months we provide a new projection for the 90-day interest rate. The changes in this projection, and the analysis in the MPS on the state of the economy, illustrate how unforeseen events have shaped the Bank’s outlook for policy.

“The publication supports transparency, and its evolution over time contributes to market participants’ understanding of how the Bank responds to unexpected economic events.

“If financial market participants have a good understanding of our ‘reaction function’, and share similar views on the economy, interest rates should adjust to levels consistent with medium-term price stability without the need for constant comment and intervention from the Bank.”

Dr McDermott stressed that the projections are conditional, reflecting the many challenges faced in forecasting the New Zealand economy.

“It is important financial market participants understand that these forecasts are not a commitment to a certain path of policy. Indeed, financial market participants generally have a very good understanding of the conditional nature of our forecasts.

“The experience since the beginning of 2014 highlights the conditional nature of our interest rate forecasts. Unforeseen economic events led to weaker-than-expected inflationary pressure in the economy. As a result, we significantly revised down the outlook for short-term interest rates. The Bank will continue to adjust monetary policy as conditions evolve to ensure that price stability is achieved over the medium term.”

Media Contact:
Mike Hannah, Head of Communications
Ph 04 471 3671, 021 497 418, [email protected]