Inflation targeting serves NZ well

Release date
30 July 2008

New Zealand's inflation-targeting framework continues to serve the economy well, but we should be careful not to ask too much of it, Reserve Bank Governor Alan Bollard said today.

In a speech titled "Flexibility and the Limits to Inflation Targeting", Dr Bollard said inflation targeting is the best approach New Zealand and many other similar countries have yet found for monetary policy, among a limited number of viable alternatives.

"Of course, we continue to seek improvements. But overall, and even in the current very difficult circumstances, the flexible inflation targeting framework positions us well to manage the ongoing shocks impacting the New Zealand economy."

Dr Bollard said monetary policy works best in an environment where wider government policies promote economic stability. Together, they help maximise long-run growth performance and prosperity. But what is also needed is savings and investment behaviour geared towards growth.

"We look forward to findings of the Finance and Expenditure Select Committee's Inquiry into the Future Monetary Policy Framework. We submitted that changes to tax and regulatory structures might help reduce their tendency to amplify economic cycles."

Dr Bollard said the New Zealand economy is subject to powerful forces and monetary policy can only do so much to buffer the shocks.

When shocks are persistent, as with oil and food prices currently, it is difficult to judge the appropriate response. Such price rises are driven by international supply and demand. The extraordinary oil price rise in particular has left New Zealand poorer and we all need to recognise this.

"Even if we wanted to, we could not stop such prices rising. We need to allow the initial price changes to occur, but keep monetary policy firm enough to ensure that generalised second-round inflation effects do not take hold. Quite simply, we cannot all pass on the higher costs to our customers or employers. If we do try to pass it on, then monetary policy will respond."

Dr Bollard said New Zealand is starting from a position of high real interest rates currently, reflecting the need to restrain inflation pressure that has built up in recent years. The current weakness in the economy allows room for rates to be cut, while ensuring inflation, and inflation expectations, come down over the medium term to within the target range.

The clear medium-term objective of 1-3 percent inflation helps to anchor inflation expectations and gives us more scope to accommodate short-term inflation shocks while ensuring that the price stability objective is not undermined in the process."

"The long, growing and diverse list of countries that followed New Zealand after our adoption of inflation targeting 20 years ago suggests strongly that it is a monetary policy strategy that can handle a wide range of circumstances and shocks."

Media contact:
Mike Hannah
Head of Communications
Ph 04 4713671, 021 497418, mike.hannah@rbnz.govt.nz