A happy "halfway-house"? Medium term inflation targeting in New Zealand

Release date
01/10/2005
Reference
DP2005/03
Authors
Sam Warburton; Kirdan Lees
Published as
Lees, Kirdan and Sam Warburton (2010). ‘A happy "half way-house"? Medium term inflation targeting in New Zealand’, Journal of International Money and Finance, Elsevier, Volume 29(5), Pages 819-839, DOI: https://doi.org/10.1016/j.jimonfin.2010.03.013.
The 2002 Policy Targets Agreement (PTA) between the Reserve Bank of New Zealand and the government asks the Reserve Bank to target inflation "over the medium term" rather than over an annual target. This medium term objective shifts inflation targeting towards a "half-way house" between inflation targeting and price level targeting. Extending the inflation averaging horizon to the medium term improves the inflation-output tradeoff by influencing inflation expectations. But how long should the medium term be? Characterizing the New Zealand economy with a small new-Keynesian model, we show that the happiest halfway house is located around a two or three year averaging horizon which leads to mild, but non-trivial, improvements in the efficiency of monetary policy.