The official cash rate (OCR)

Hi, I’m Paul Conway, Chief Economist at Te Pūtea Matua, the Reserve Bank of New Zealand.

I’ve got 5 things I’d like to let you to know about how we do forecasting and monetary policy at the bank.

First, the best thing that we can do with monetary policy for the material wellbeing of New Zealanders is to keep inflation low and stable. Because low inflation means that we can all plan and invest better and that the purchasing power of our wages is not eroded by rising prices.

Second thing, we use interest rates - the Official Cash Rate - to control inflation. For example, over the past few years we have reduced inflation from above 7% to near our 2% inflation target midpoint. Now we do this gradually through time, because trying to bring inflation back to target all at once could sometimes cause unnecessary volatility in the economy.

Three, interest rates take a long time to fully impact inflation in the economy. So we need to project where the economy will be in future so that we can make the right interest rate calls today. We can't see into the future, unfortunately, but with good data, good research, good economic models and highly skilled people, we can get a sense of where the economy is headed.

We need to be like All Whites Captain Chris Wood. He scores goals by moving to where the ball is going, rather than where it is right now.

Four, to forecast the future, we need to know where the economy is at today. Now, that is easier said than done, because official data, it often arrives with a lag and it is often revised. So we do something called nowcasting. And this involves looking at all sorts of data - things like retail spending, the results of business surveys, or car and truck movements - heaps of data. And as that data becomes available, we run it through a model that gives us a nowcast of, for example, GDP growth.

And we've actually just started publishing our nowcasts for GDP growth on our website. We'll update that every Friday afternoon to reflect the data that's come in over the week. So check it out. It's called Kiwi-GDP.

And the final point I want to make, point five, is that our OCR forecasts are always conditional. It is our best foot forward on the day. So as the economic picture changes, and it always does to some extent, our projection for the OCR changes too. So the track for future interest rates is never guaranteed.

Thank you for tuning in.

Ka kite.

Audio: Kia ora, I'm Paul Conway, Chief Economist at the Reserve Bank of New Zealand. Here at Te Pūtea Matua, we use the OCR or Official Cash Rate to achieve and maintain price stability and support maximum sustainable employment in our economy. Our goal is to keep inflation between 1 and 3% over the medium term. But lately inflation has been far too high. For this reason, we have been increasing the OCR to reduce spending and encourage savings. So how does raising the OCR help bring down inflation? Well, higher interest rates make it more expensive for people to borrow and encourage people to save. Borrowers with a mortgage or other debt have to increase their interest payments and so tend to spend less as interest rates rise.

Savers, people with money in the bank earn a higher return on their savings, encouraging them to save more. Higher interest rates also tend to increase the exchange rate, making it effectively cheaper to buy foreign products or imports, which also help bring down overall inflation.

Higher interest rates also mean New Zealanders expect lower inflation in future, which encourages businesses to set lower prices for their products today and for workers to accept lower pay increases, which also works to lower inflation in our economy.

Text on screen: How does the official cash rate affect interest rates in the economy?

Audio: The OCR effectively sets the interest rates on the deposits and loans that commercial banks hold with the Reserve Bank. Banks tend to set the interest rates that they charge and pay on mortgages and deposits over the life of the loan or deposit. So, for example, a two year mortgage rate will factor in what banks predict the OCR to be over the two year term of the loan.

Text on screen: How will raising interest rates affect New Zealanders?

Audio: If you have a floating rate on a loan or mortgage, you're no doubt finding that the cost of your repayments are going up. If you have a fixed rate mortgage, then repayments remain the same until the end of that fixed rate period. And if you have savings, you'll be noticing that you're earning a bit more interest on your money than you were, say, a couple of years ago when interest rates were exceptionally low. This will encourage New Zealanders to spend less and to save more, which will help bring inflation down in our economy.

Inflation is no one's friend. It makes life more expensive and complex for New Zealanders. It's like a pay cut and a tax on your savings rolled into one. This is why it's crucial for the Reserve Bank of New Zealand to get inflation back into our target range. Thank you.