Monetary policy grapples with drivers of weak inflation

Release date
05 December 2017

Inflation in New Zealand and world-wide has been persistently low since the 2008 global financial crisis, partly because of factors such as globalisation, the growth of China, the rise of the digital economy, and low inflation expectations.

In a speech today to the Institute of Directors, in Auckland, Reserve Bank Governor Grant Spencer said that persistently low inflation has prompted the Reserve Bank to think about whether it needs to tweak it’s approach to monetary policy.

Mr Spencer explained a number of significant changes over the past decade have affected the outlook for inflation:

  • Globalisation over the past 10 years has led to outsourcing of labour-intensive production to cheaper locations, which has lowered the price consumers pay for a wide range of goods and also placed downward pressure on wages for lower-skilled jobs in advanced economies.
  • The scale and growth of China’s economy has also had a profound effect. China has become the largest exporting nation in the world and its expansion of capacity has restrained the prices of industrial materials and a wide range of manufactured goods.
  • New digital distribution channels and falling prices for ICT equipment have lowered import prices and reduced barriers to entry across a range of markets. Online competition in retailing, financial services, travel services, education and health has significantly altered the competitive landscape and put downward pressure on prices.
  • The domestic economy has become more integrated with global markets, resulting in greater competition in traditionally sheltered sectors. Increased international labour mobility has been an important driver.
  • Low inflation expectations have influenced the way businesses set prices and wages, adding further momentum to low inflation.

These global trends appear to be changing the nature of the price formation process in New Zealand.

“These factors may be reducing the leverage monetary policy has over inflation, although their persistence and impact on inflation in New Zealand remain uncertain,” Mr Spencer said.

Monetary policy has less than fully offset the weakness in imported inflation which was not expected to be so persistent and has been overlaid with uncertain commodity price movements. The on-going shock has resulted in CPI inflation running below the 2% target mid-point. The policy response has been consistent with our flexible inflation targeting framework. More recently we have been assuming greater persistence in low global inflation and this is contributing to our current flat track for future OCR levels.

“The changes in domestic pricing behaviour are causing our flexible inflation targeting approach to become more flexible. In pursuing our long term price stability objective, relatively more weight is being attached to output, employment and financial stability. However, this can only be sustained if monetary policy’s long term price stability credentials are maintained” Mr Spencer said.

Read the speech: Low inflation and its implications for monetary policy

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