MNI ANALYSIS: New RBNZ Agreement Gives Performance Flexibility

By Sophia Rodrigues

     SYDNEY (MNI) - The Reserve Bank of New Zealand will have greater

flexibility for inflation targeting in the new Policy Targets Agreement (PTA) as

the removal of the word "average" for the inflation target will make performance

measurement less rigid, allowing them to focus on stable prices and other

related goals of monetary policy.

     Earlier Monday, incoming RBNZ Governor Adrian Orr and Finance Minister

Grant Robertson signed a new PTA which, for the first time, has employment

outcome as an additional consideration in the conduct of monetary policy. Such a

change was already well-flagged, so didn't come as a surprise.

     There were other changes too, resulting in a more concise PTA but with

greater clarity. The most significant change was the dropping of the word

"average", and the inclusion of the word "flexible" in the inflation targeting

regime.

     "The agreement continues the requirement for the Reserve Bank to keep

future annual CPI (consumer price index) inflation between 1 and 3 percent over

the medium-term, with a focus on keeping future inflation near the 2 percent

mid-point. The new PTA now also requires monetary policy to be conducted so that

it contributes to supporting maximum levels of sustainable employment within the

economy," a joint statement by the RBNZ and the Minister of Finance said Monday.

     The statement removed reference to "average", both for keeping future

annual CPI inflation between 1% and 3% over the medium-term, and for the focus

on keeping future inflation near the 2% mid-point. 

     The RBNZ will also implement a flexible inflation targeting regime that

will have regard to the efficiency and soundness of the financial system, seek

to avoid unnecessary instability in output, employment, interest rates, and the

exchange rate, and respond to events whose impact on inflation is expected to be

temporary in a manner consistent with meeting the medium-term target.

     --PATH IMPORTANT, NOT AVERAGE

     Deleting "average" from inflation targeting essentially removes the

rigidity because the RBNZ needs to just ensure inflation in future remains

within the target band, with a focus on near-2%. This means the RBNZ will have

less explaining to do when inflation is above or below the band, as long as it

shows the path towards 2%. 

     In the current monetary policy cycle where annual CPI inflation has been

below the 2% mark for 24 of the last 25 quarters, this assumes greater

significance. Just because CPI has been below the 2% mark for so long, it

doesn't mean the RBNZ will have to keep inflation above 2% to have a average of

around 2%. The future target band and the focus on 2% is all that is important.

     This flexibility is important because of the inclusion of full employment

in the mandate, as it could mean slightly less focus on the previous mandate of

just inflation-targeting.

     In the current cycle, it could potentially allow the RBNZ to raise the

official cash rate sooner than previously expected, if for example, a higher OCR

is needed for other reasons, including the exchange rate or if global

developments become a compelling reason to change monetary policy.

     It might also mean the RBNZ could keep the OCR on hold for longer because

its performance wont be measured by "average" inflation.

     Similarly, in future, in a different cycle, the RBNZ would get more

flexibility to keep the OCR lower to maximise employment, even when inflation is

above the target band.

     --ASSET PRICES

     Another change in the PTA was the removal of monitoring of prices,

including asset prices in pursuing price stability. Instead, it just says the

RBNZ "is required to conduct monetary policy with the goal of maintaining a

stable general level of prices."

     Asset prices were specifically included in the PTA in 2012 when Graeme

Wheeler took over as governor. So removing that takes it back to the RBNZ Act

which says "The primary function of 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."

     It is unclear why "asset prices" was removed from the PTA but the likely

reason was perhaps that there was never any clarity on how it should influence

monetary policy.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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