Monetary policy tools
How we use monetary policy tools to control inflation and support maximum sustainable employment – monetary policy’s best contribution to the prosperity and well-being of New Zealanders.
We use a range of tools to achieve our mandate
As the Reserve Bank of New Zealand – Te Pūtea Matua, our mandate is to create the conditions that promote full employment and maintain the purchasing power of your money into the future.
The economic downturn caused by the COVID-19 pandemic in 2020 made it harder for us to achieve our mandate, with unemployment initially rising and inflation falling.
In response, we used a range of tools to lower interest rates and support the economy and the labour market by encouraging households and businesses to spend and invest.
Our actions created an environment that supports economic recovery by encouraging households and businesses to spend and invest when they feel more confident to do so.
Without these actions, it is likely the economic downturn would have been more severe, leading to higher unemployment and forcing more businesses to close for good.
Tools we are currently using
We have traditionally used the official cash rate (OCR) to control inflation and maximise employment.
The OCR influences the price of borrowing money in New Zealand and provides us with a way of influencing the level of activity and inflation in the economy.
To provide extra support for the economy in response to the downturn caused by the COVID-19 pandemic, we began considering and using other tools to lower interest rates.
Our seven-member Monetary Policy Committee makes the final decision on whether other tools are needed, and if so, which ones and when. The committee evaluates each tool against a set of principles to decide which one is best to achieve our inflation and employment mandate.
In March 2020, we announced the OCR would remain at 0.25% for the next 12 months. This is an example of forward guidance and provides an assurance to households and businesses about the future path of interest rates, giving them some certainty around their spending and investment plans.
Large-scale Asset Purchase programme
The Large-scale Asset Purchase (LSAP) programme (also called quantitative easing or QE), involves us buying government bonds from banks in exchange for electronically created money. Injecting cash into the economy effectively lowers all other interest rates, including those affecting lending rates for mortgages and businesses.
Lower borrowing costs leaves more money in the pockets of households and extra cash flow for businesses, providing more confidence for them to spend and invest.
In contrast, savers will experience lower returns. The effect on deposit rates is like a fall in the OCR, which happened during the Global Financial Crisis in 2008.
We halted additional purchases under the LSAP programme on 23 July 2021 after the Monetary Policy Committee agreed to reduce the current stimulatory level of monetary settings to meet its consumer price and employment objectives over the medium term.
Funding for Lending Programme
The Funding for Lending Programme (FLP) allows eligible banks to borrow from us at the OCR. The entire programme is worth up to $28 billion.
This programme means banks are less reliant on more expensive deposits and wholesale lending, which lowers their overall funding costs.
In turn, this lets banks pass on the reductions to their customers through lower mortgage and business-lending rates. As banks are also less reliant on funding from savers, it is also likely to lower term deposit rates.
For borrowers, lower interest rates mean there is more money in their pocket to spend on other things. In contrast, savers are likely to see lower returns.
New tools we are preparing
Negative official cash rate
Our February 2021 Monetary Policy Statement announced that, with the necessary work to ensure our financial system is ready to operate in a zero or negative interest rate environment complete, our toolkit can now include the option of a zero or negative official cash rate (OCR).
Introducing a negative OCR means we would lower the OCR below zero. With a negative OCR, banks would have to pay to keep their settlement balances with us, rather than earning interest as they would when the OCR is positive.
Lowering the OCR below zero would work in much the same way as lowering the OCR when it is above zero. It would reduce market interest rates, which would then flow through into the wider economy.
This does not mean those with on-call savings accounts or term deposits would have to pay to keep their money in the bank. The negative rates would only apply to banks’ wholesale customers such as other financial firms and large corporates. In other countries with negative policy interest rates, deposit rates for households have generally stayed at or above zero, even as other interest rates have declined. We expect that this would also be the case in New Zealand.
We have considered this tool operationally ready since our February 2021 Monetary Policy Statement.
Foreign asset purchases
Foreign asset purchases involve selling New Zealand dollars to buy foreign currency or assets.
This would increase the supply of New Zealand dollars and lower the New Zealand dollar exchange rate, which would improve the competitiveness of exporters and raise inflation by making imports more expensive.
Interest rate swaps
An interest rate swap is a contract where one stream of future interest payments is exchanged for another.
We could enter into interest rate swaps to receive fixed rates and pay floating rates to financial market participants. This is the equivalent of ‘putting our money where our mouth is’ and would reinforce forward guidance (see above) to keep interest rates low.