New Zealand Central Bank
Since the unanimous passage in New Zealand’s Parliament of the Reserve Bank of New Zealand Act in 1989 due to dire economic conditions in the 1980’s and interest rates in the 18 percent range, the central bank gained a greater independence from central government control. Both New Zealand’s major parties, Labour and National , voted overwhelmingly to support a first ever agreement within industrialized nations called the Policy Targeting Agreement to achieve price stability by explicitly targeting inflation. Since New Zealand’s passage, the Bank of Canada in 1991, Bank of Australia in 1992, Bank of England in 1992,
Sweden’s Riksbank in 1993 and a vast majority of nations adopted a monetary policy form of inflation targeting that gave central bankers greater independence and restrained disastrous fiscal policies by central governments.
New Zealand’s economy throughout the 1980’s suffered from low productive output, exchange rate risk not aligned with the economy and exports and elevated interest rates in the 18 to 20 percent range. From 1990 to the present, interest rates averaged about four percent in New Zealand but remained below worldwide averages by 2.7 percent from 1988-2000 and remains low and competitive today. Most credit the Policy Targeting Agreement with its main focus on price stability and the central banks focus on transparency and accountability to keep inflation low.
Eight agreements have been signed since 1989 between the minister of finance and the reserve bank president as defined by section 9 of the law and each agreement defines monetary targets for inflation and price stability in broad ranges with a two or three point spread. The wide spread allows for possible economic price shocks because the minister of finance can fire the reserve bank president if prices fall outside the intended target, an unlikely event.
Another unlikely event is agreements are renegotiated and introduced that coincide with election cycles that allow for monetary policy manipulation. The government can direct a different monetary target and even a different agreement anytime but an Order -In -Council within the New Zealand Parliament would have to be submitted along with a public statement of explanation, highly unlikely. Monetary policy statements such as quarterly interest rate decisions are reviewed by members of both political parties in the Finance and Expenditure Committee within New Zealand’s Parliament and reviewed for accuracy.
Statistics New Zealand surveys, collects, issues and monitors New Zealand’s All Groups Consumer Price Index on a quarterly basis that reflects prices of 9 groups, 21 subgroups with 73 sections. The 9 groups include food, housing, household operations, apparel, transportation, tobacco and alcohol, personal and healthcare, recreation and education and credit services. 700 items are price surveyed every quarter to gauge prices within the economy, to gauge prices for Policy Target Agreement objectives of price stability and inflation and to guage the level of interest rates. To accomplish this, the Price Index was set in June of 1999 with a base price of 1000.
The All Groups Consumer Price Index comes with the caveat to ask not only what are the present level of prices but what will prices be in percentage terms in the future. For example, September 2000 had a 1034 consumer price and 1051 in September 2001. To factor the increase in prices, 1051 minus 1034 divided by 1034 and multiply by 100 = a 2.4 percent increase in prices over a one year period. Chances are good that the 2.4 percent year over year increase in prices fell right in line with the Policy Target Agreement and inflation expectations. Statistics New Zealand is charged with various statistical monitoring and price projections. The focus for CPI numbers and agreement objectives is the overall headline number rather than the core number that subtracts food and energy prices.
New Zealand’s Central Bank called the RBNZ or the Royal Bank of New Zealand is further charged by the Policy Target Agreement to conduct open market operations to target the settlement of their cash balances. Such transactions would include interbank operations. To hold non negative balances is illegal under the Reserve Act law.
A recent implementation is to target a band of interest rates for open market operations rather than set targets. Section 13 of the Policy Target Agreement further charges the central bank with conducts of interest rates and exchange rates and to avoid unnecessary instability in output.
To understand New Zealand’s economy and to stay within inflation targets, the central bank since 1997 employed a macroeconomic model called the Forecasting and Policy System. While this system served its purpose, KITT or the KIWI Inflation Targeting Technology system recently replaced the forecasting system in June 2009. Not only does this appear to be a better system but the central bank now focuses more closely on the factors of their economy. For example, if inflation is a factor of supply and demand as they suspect, what are the factors of supply and demand in the economy.
The structure of the economy can be viewed in four sectors that tie into GDP, non trade able goods producers, trade able goods producers, producers of residential investment and exporters. To understand the correlation of these factors allows a closer monitor of Policy Targets by using such instruments as fan charts to plot the present economy and prepare for future economic events. Fan charts were originally adopted by the Bank of England.
To understand household patterns of consumption based on trade able, non trade able, housing services, fuel and house prices will allow a better understanding of CPI and inflation and further allow an enhanced forecasting method with accuracy. What are the marginal costs to firms doing business and what about construction costs. Currently, construction costs make up 5.5 percent of New Zealand’s economy. With this information, what would housing prices cost and can the KITT system forecast better costs. Absolutely.
While microeconomic variables is an important factor for economic and inflation purposes, KITT also addresses macroeconomic variables as a forecast tool such as inflation, output, interest rates and exchange rates.
Exchange rates are highlighted in Clause 4B of the PTA. All are factors due to possible shocks to the system. What would occur in the New Zealand economy if the New Zealand dollar rose or fell by extreme proportions.The primary focus of KITT is the focus on the domestic economy with faster responses of economic conditions as a better forecasting tool using its 27 data sources. Clearly a central bank that has stayed on the leading edge of technology and intelligence for over 20 years.
December 2009 Brian Twomey
Brian Twomey is a currency trader and adjunct professor of Political Science at Gardner-Webb University