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Improving implementation of inflation targeting in New Zealand: an investigation of the Reserve Bank's inflation errors

Philip Liu

I investigate New Zealand's rate of inflation and its deviations from target using two new methods: 1) Rowe's (2002) new way of examining the correlations between inflation deviations from target and indicators. Any significant correlations, whether in a simple or multivariate framework, are interpreted as evidence against optimal policy setting. 2) Cukierman and Gerlach (2003) and Ruge-Murcia's (2001) new inflation bias hypothesis. As a counterpoint to Kydland and Prescott's (1977) and Barro and Gordon's (1983) time inconsistency explanation of inflation bias, Ruge-Murcia, Cukierman and Gerlach take the different view that even if central banks target the natural rate of unemployment or the potential level of output, some inflation bias might still exist if their loss function is asymmetric. I examine the inflation errors from 1982 to 2003 to investigate how information contained in these might be used to improve future inflation targeting in New Zealand.