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How the Reserve Bank implements monetary policy

This Bulletin provides an overview of how we implement monetary policy and manage settlement cash in the banking system.

Michael Callaghan, Cameron Haworth, Kate Poskitt

How the Reserve Bank implements monetary policy
How the Reserve Bank implements monetary policy

This Bulletin provides an overview of how we implement monetary policy and manage settlement cash in the banking system.

About the Bulletin

This Bulletin covers a wide range of issues related to central banking, the financial system and the New Zealand economy.

We are responsible for ensuring that short-term interest rates are near the OCR and for supplying enough settlement cash so that banks can settle payments that occur throughout the New Zealand economy. 

We provide settlement accounts for banks and other financial institutions through the Exchange Settlement Account System (ESAS). The interest rate earned on settlement cash balances flows through the financial system through wholesale interest rates to retail banking interest rates, which impact borrowing and saving rates for New Zealanders.

This Bulletin also discusses:

  • how our monetary policy implementation framework has evolved
  • features of different monetary policy implementation frameworks
  • the steps we have taken in recent years to improve the implementation of monetary policy
  • the outlook for liquidity operations.

Monetary policy implementation

The Monetary Policy Committee sets the stance of monetary policy by adjusting the level of the Official Cash Rate (OCR). This determines whether monetary policy is a “headwind” or “tailwind” for economic activity and inflation. But for the OCR to affect the economy, it must first transmit through New Zealand’s financial system. 

We ensure effective monetary policy implementation through a framework of facilities and operations that anchor short-term interest rates at or near the OCR.

Find out more about our monetary policy implementation framework

Key facilities

Our monetary policy implementation objectives

We have 2 monetary policy implementation objectives:

  • Ensuring that short-term market interest rates trade at or near the OCR
  • Managing settlement cash in the banking system to facilitate payments and settlement flows.

The transmission of the OCR through the financial system starts with overnight cash markets, where commercial banks transact to make sure they have the appropriate cash balance to meet their daily needs. Short-term interest rate markets are used by financial market participants to borrow and lend cash. These short-term interest rates are important as they influence longer-term interest rates and financial conditions more broadly in the economy, including interest rates faced by households and businesses.

How we anchor short-term interest rates

The primary way that we anchor short-term interest rates in New Zealand at or near the OCR is by paying an interest rate equal to the OCR on banks’ settlement account balances.

We also conduct operations and offer facilities where market participants can borrow and deposit settlement cash — the electronic cash held in accounts with us to settle payments between commercial banks — to ensure that trading in these markets stays close to the OCR. This also ensures there is enough settlement cash in the banking system for payment and settlement needs, so market participants can settle transactions effectively.