One of New Zealand’s major economic problems during the last decades of the twentieth century was inflation – rising prices.
Both inflation and its opposite, deflation, had long been known to be damaging to an economy. Through much of New Zealand’s history, there had been numerous episodes of inflation rising, particularly after economic shocks. There had also been episodes of deflation, typically during economic depressions. More usually, though, prices tended to rise.
Keeping prices stable was part of the Reserve Bank’s function from the outset, a task written as a general principle into the various Acts that defined and re-defined the Bank’s functions over the years and decades.
Typically, price stability was only one of a number of targets, such as a particular exchange rate or employment levels. It was not easy to achieve all of these targets with the tools the Bank had available. Sometimes it was impossible. In some ways this was not a problem, because in the mid-twentieth century, New Zealand’s economic experience did not lead to particularly high or sustained inflation.
But that changed in the late 1960s, and more so in the 1970s, when New Zealand was struck by one economic shock after another. Inflation began climbing, and by the early 1980s it was approaching record levels. It was sustained, and it was also volatile, which meant price changes were unpredictable.
A new approach was proposed by the Bank in the late 1980s and written into the Reserve Bank of New Zealand Act 1989. It made price stability the prime function of the Bank..
The Reserve Bank of New Zealand Act 1989
This Act required the Bank to ‘deliver stability in the general level of prices’. The word ‘stability’ meant that the Bank had to fight not just inflation, which was the problem of the late 1980s. It also had to be vigilant against deflation, steadily falling general prices, which is just as damaging to an economy and had occurred, for example, during the Great Depression of the early 1930s.
This Act marked the first time, anywhere in the world, that a central bank had been given a statutory focus on keeping prices stable as its primary function. Since then, many countries have followed suit in targeting inflation.
The principal tool the Bank had available to achieve this was monetary policy – the control the Bank had of the supply of money in the economy. Since 1999, that has been implemented via the Official Cash Rate (OCR), which – in effect – is the ‘wholesale’ price of borrowed money.
Policy targets agreements
The 1989 Act stated that the specific targets for which the Bank had to aim would be set out in an agreement between the Governor and the Minister of Finance - a Policy Targets Agreement.
This was another unique innovation at the time. The first Policy Targets Agreement (PTA) was signed in March 1990 and specified that the Reserve Bank should target a reduction in inflation, as measured by the changes in the Consumers Price Index, to between 0 and 2% by 1992.
PTA’s have been negotiated and signed by successive Governors and Ministers since March 1990. All followed a similar general pattern in setting a target of inflation within a low and narrow range.
Currently, the Government has set us an inflation target of keeping inflation between 1% and 3% over the medium term, with a focus on keeping future inflation near the 2% midpoint.
