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New Zealand Economic and Financial Overview 2015

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 September 2012 on the appointment of a new Governor.

For the purposes of the PTA, the policy target remains to keep future CPI inflation outcomes in the range of 1% to 3% on average over the medium term, but with the additional requirement to ‘focus on keeping future average inflation near the 2% target midpoint'.

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. A 2012 amendment incorporates in the PTA the existing statutory requirement to implement monetary policy in a way that ‘has regard to the efficiency and soundness of the financial system', recognising the importance of financial system issues during the GFC.

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 PTA. The OCR, the deposit rate the Bank pays on settlement account balances, influences the price of borrowing money in New Zealand and provides the Bank with a means of influencing the level of economic activity and inflation.

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.

The 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.

After a prolonged period of very low policy interest rates, the Reserve Bank raised the OCR in four steps from 2.5% to 3.5% during 2014. Inflation remains low but excess capacity in the economy has been increasingly used up over the past few years and the Christchurch rebuild has provided considerable impetus to demand.

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