Managing monetary policy in a turbulent world

Release date
14 October 2015

Central banks in small open economies face turbulent global conditions and must deal with complex financial and economic linkages, Reserve Bank Governor Graeme Wheeler said today.

"The inflation targeting framework and Policy Targets Agreement (PTA) have provided a sound anchor for policy in this uncertain world; yet judgement in managing and balancing risks plays a critical role," Mr Wheeler said.

Speaking to the INFINZ annual conference in Auckland, Mr Wheeler said that the PTA between the Bank and the Government has, since 2012, required the Bank to focus on keeping future average CPI inflation near the 2 percent midpoint of the target range.

"Including the reference to the midpoint in a medium-term context was aimed at lowering and stabilising inflation expectations close to 2 percent. Recent data are positive on this front. Survey measures of inflation expectations have fallen and are now consistent with inflation settling at 2 percent in the medium term," Mr Wheeler said.

"The PTA explicitly recognises (as has been the case), that annual headline inflation may fall outside the target band because of exceptional movements in commodity prices. The medium-term focus of policy means that the Bank does not try to immediately correct deviations of inflation from its target range, but aims to do so steadily over time."

The PTA also requires the Bank to have regard to the potential impact of its monetary policy decisions on financial imbalances in the economy.

"We have used macro-prudential policy instruments and some prudential management interventions to help reduce the risks to the financial system and broader economy associated with a potential correction in Auckland house prices. Although financial stability considerations are secondary to the price stability objective in the PTA, housing market considerations do influence our thinking on the OCR."

In his speech, Mr Wheeler reflected on the uncertain world in which central banks operate. Global economic growth is the weakest since 2009. Inflation has also been below target over the past few years in most of the 30 or so economies whose central banks pursue inflation targeting.

"The New Zealand economy has been affected by several major shocks and adjustments in recent years. These include: the Canterbury earthquakes and subsequent rebuild activity; the 2013 drought; the terms of trade hitting a 40-year high; the 70 percent decline in dairy prices and early signs of a recovery in recent weeks; the 60 percent decline in oil prices; the related large swings in the real exchange rate; net migration and labour force participation reaching historically high levels; and annual house price inflation in Auckland reaching 26 percent, with house-price-to-income ratios that are double those in the rest of New Zealand. All this has taken place in the context of unprecedented global monetary accommodation and, more recently, a significant slowdown in China and other emerging market economies."

Mr Wheeler said: "Recent economic indicators have been more encouraging. Some further easing in the OCR seems likely, but this will continue to depend on the emerging flow of economic data. At the same time, however, we remain conscious of the impact that low interest rates can have on housing demand and its potential to feed into higher price inflation. It is important also to consider whether borrowing costs are constraining investment, and the need to have sufficient capacity to cut interest rates if the global economy slows significantly."

Mr Wheeler said that central bankers' goal of trying to smooth output gaps around the path of potential output has not changed. "But they are tasked with doing so while the global economy is in a difficult configuration with growth slowing in the developing world, unprecedented monetary accommodation, and prospects of tighter monetary conditions in the US, and further easings in the euro-area and Japan. Little wonder that central bankers closely dissect new data and information, and cautiously feel their way with their policy responses."

Media Contact:

Mike Hannah, Head of Communications,

Ph 04 471 3671, 021 497 418, mike.hannah@rbnz.govt.nz