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Monetary Policy

Objectives

The Reserve Bank of New Zealand Act 1989 stipulates that the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices. The Act requires that there be a Policy Targets Agreement (PTA) between the Minister of Finance and the Governor of the Reserve Bank. The most recent PTA was signed in December 2008 after the new government took office. There were no substantive changes to the Agreement. For the purposes of the PTA, the policy target is to keep future CPI inflation outcomes in the range of 1% to 3% on average over the medium term.

Section 3 of the PTA notes that there is a range of events that will cause the actual rate of CPI inflation to vary about the medium-term trend. When such events occur, the Bank is tasked with responding in a manner consistent with meeting its medium-term target.

The PTA requires the Bank, in pursuing the price stability target, to seek to avoid unnecessary instability in output, interest rates and the exchange rate and to implement policy in a sustainable, consistent and transparent manner.

The Reserve Bank Act provides the Bank with autonomy to carry out monetary policy in pursuit of the price stability objective. However, the Act contains certain provisions that enable the government to override the price stability objective and the PTA, provided this is done in accordance with a set of procedures that would make the override publicly transparent. These provisions have never been used.

Implementation

The Official Cash Rate (OCR) is the interest rate set by the Reserve Bank to meet the inflation target specified in the Policy Targets Agreement. The OCR, the deposit rate the Reserve Bank pays on settlement account balances, influences the price of borrowing money in New Zealand and provides the Reserve Bank with a means of influencing the level of economic activity and inflation. An OCR is a fairly conventional tool by international standards.

The OCR is reviewed eight times a year by the Bank. The Bank's Monetary Policy Statements are issued at the same time as the OCR on four of these occasions. Unscheduled adjustments to the OCR may occur at times outside these set dates in response to unexpected or sudden developments but, to date, this has occurred only once - following the attacks on the World Trade Centre in New York on 11 September 2001.

The Reserve Bank sets no limit on the amount of cash it will borrow or lend at rates related to the OCR. The Bank stands ready to lend cash overnight at 50 basis points above the OCR when secured over acceptable collateral in its overnight reverse repurchase facility. Overnight balances in exchange settlement accounts are remunerated at the OCR.

The Bank publishes an assessment of economic conditions at quarterly intervals in its Monetary Policy Statements. The Statements contain projections that incorporate a forward path for interest rates that is consistent with achieving the inflation target. These projections are highly conditional, being based on a range of technical assumptions, but they serve to provide an indication of the Bank's current thinking on the policy outlook.

From 2004 until mid-2007, monetary policy was in a tightening phase with the Reserve Bank increasing the Official Cash Rate (OCR) by a total of 325 basis points from 5.0% in January 2004 to a peak of 8.25% in July 2007. The policy tightening reflected a prolonged period of strength in the domestic economy which left productive resources stretched and led to a rise in non-tradable inflation. The onset of the global and domestic recession prompted sharp falls in the OCR, reaching 2.5% by April 2009. The OCR was increased in mid-2010 but, following the Canterbury earthquake in February 2011, it was cut back again to 2.5%, where it has remained.

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