Modelling New Zealand inflation in a Phillips curve

Release date
Vol. 69. No. 3. Sep 2006
David Hargreaves; Hannah Kite; Bernard Hodgetts
This article presents some simple estimates of Phillips curves for New Zealand inflation and outlines a recent reorganisation of the inflation process in the Reserve Bank’s Forecasting and Policy System (FPS). While modern economic theory suggests the traditional Phillips curve should be used only with care, empirical estimates for New Zealand suggest it continues to have some value. We find that estimates of the impact of resource pressure (the “output gap”) on inflation are easiest to obtain from an equation on the non-tradables component of CPI inflation, and show that this relationship can be improved statistically by introducing a (fairly smooth) measure of inflation expectations on the right hand side. We present some evidence that the relationship between resource pressures and non-tradables inflation is stronger in New Zealand than some comparable countries, and further evidence that this could be related to the cyclicality of housing construction costs in New Zealand. In the latest version of the Reserve Bank’s macro-model, FPS, the inflation process has been written with a tradables/non-tradables split and an explicit empirical measure of inflation expectations. This does not greatly change model properties but allows the model’s congruence with the data to be assessed more directly.