The importance of potential output

Release date
09 July 2014

A key component of the Reserve Bank's approach to monetary policy is determining the potential for the economy to grow without generating inflationary pressures, Reserve Bank Assistant Governor John McDermott said today.

Speaking to the Wellington Chamber of Commerce, Dr McDermott said that higher growth in potential output is desirable. But whatever the state of potential output, identifying and influencing the fluctuations of actual output around the path of potential output – the ‘output gap' – is the focus of monetary policy.

"Potential output is determined by the supply of labour and capital, and the efficiency with which these factors are utilised. The quantity and quality of these productive inputs are largely determined by the preferences and choices made by individuals and businesses – how much to work, how much to save, and how much to invest. Monetary policy cannot persistently affect these preferences in a way that would raise potential growth.  On the other hand, poor monetary policy that results in high inflation would distort these decisions and lower long-run growth."

"The best contribution that monetary policy can make to strong and sustainable long-run growth is low and stable inflation. This proposition is at the heart of New Zealand's flexible inflation-targeting framework to maintain price stability while not causing excess volatility to output, interest rates or the exchange rate."

Read the speech to the Wellington Chamber of Commerce.

Media Contact:
Naomi Mitchell, External Communications Adviser
Ph 04 471 3960, mob 027 485 9474, naomi.mitchell@rbnz.govt.nz