7 Conclusions
The principal aims of this paper were to attempt to answer the following three questions. Has the focus on inflation targeting in New Zealand since 1989 resulted in monetary policy accentuating or dampening business cycles? What was the impact of monetary policy on the variability of inflation? How has monetary policy affected the trade-off between the output and inflation variances?
We found that during inflation targeting, monetary policy has tended to have a countercyclical impact on New Zealand growth cycles. The general countercyclical nature of monetary policy in New Zealand is consistent with recent research evaluating Australian and United States monetary policy. Dungey and Pagan (2000) concluded that Australian monetary policy was generally countercyclical during the 1980s and 1990s. Clarida, Gali and Gertler (2000) concluded that the effect of monetary policy in the United States during the Volker-Greenspan era was also generally countercyclical.
However, there have been exceptions to this pattern. Monetary policy accentuated the business cycle upswing during 1994 and 1995. Monetary policy also accentuated the 1998 recession; although its impact was small compared with the more substantial impact from adverse climatic conditions.
In general, monetary policy operating under inflation targeting has tended to reduce the variability of output and inflation around their trend levels. During the first six years of inflation targeting, monetary policy contributed to a fall in inflation variability. This result was associated with monetary policy inducing lower output variability in most quarters, an outcome that is consistent with improved monetary policy credibility.
From 1996 to 2001 monetary policy was less effective in reducing inflation variability and output variability. From June 1997 to March 1999 the Reserve Bank was using a Monetary Conditions Index (MCI) to guide the interest rate decisions. This period also included the impact of the Asian crisis and a large domestic climate shock. Although previous research has questioned the merits of using an MCI in a small open economy, it is difficult to identify whether the outcome was a consequence of using an MCI or whether the operation of monetary policy was rendered more difficult because of the unusual nature of the shocks and a lack of understanding of the dynamic effects of these shocks. There was, however, less scope for monetary policy to reduce variability as output and inflation variability from other sources were lower in this latter period. For whatever reason, the evidence suggests that at no stage during the period when the MCI was operating did monetary policy reduce output variability and for all but two quarters it increased output volatility.
The techniques used in this paper provide a basis for investigating the impact of other policy shifts and their impact on other macroeconomic variables. They could also be applied to compare the impact of policies across countries. For example, in view of the debate concerning the relative efficiency of Australian and New Zealand monetary policy in recent years, one extension could be to use these techniques to compare the relative contributions of monetary policy to New Zealand and Australian business cycles and inflation variability.
