New RB Governor likely to set more relaxed inflation target

By NZPA

Monday 16th September 2002

Finance Minister Michael Cullen and Reserve Bank governor-designate, Alan Bollard, will tomorrow sign a new Policy Targets Agreement (PTA) that is likely to relax the operation of monetary policy.

Dr Cullen said today the agreement, detailing how the bank is required to achieve "price stability", would be published at 9am. A scheduled lock-up briefing for journalists and news conference suggest there will be substantial change to the current PTA.

He has said previously he wanted the Reserve Bank to move towards how the Reserve Bank of Australia operates monetary policy.

Business and economists have mixed views on whether a change would produce the higher economic growth rates any relaxation would be aimed at achieving.

Dr Cullen said when he announced Dr Bollard would become the new governor, that he did not want to widen the 0-3 percent inflation target in the new PTA, but he wanted "monetary policy outcomes to move closer to those of Australia".

The Australian central bank is directed to keep inflation within a 2 to 3 percent band on average over the business cycle.

Such a change would allow the central bank to refrain from slamming on the monetary brakes by hiking interest rates if the annual inflation rate climbs over 3 percent but the economy is back-pedalling.

Other options Dr Cullen is mulling over include abandoning a target band in favour of a single point target or simply narrowing the band to 1-3.

The change in the band would force the bank to aim at a higher mid-point than the current 1.5 percent target.

The Reserve Bank under former governor Don Brash and acting governor Rod Carr argues there would be no practical difference in how monetary policy has been operated in the last few years -- as evidenced by the 2.5 percent average inflation rate over the last three years.

A single point target was recommended by Professor Lars Svensson of Sweden in his independent review of monetary policy last year, but that was then rejected by Dr Cullen.

Critics of the current regime, such as the Council of Trade Unions, argue that squeezing the last drop of inflation from the economy has greater costs than benefits. It believes slower growth results.

Business New Zealand does not want the target changed but agrees the time focus to achieve it should be moved out from 12 months to the "medium-term".

The debate over inflation targeting has arisen from the frustration that New Zealand cannot achieve a stronger growth rate -- having slid rapidly down the OECD ladder and well behind Australia through the 1990s.

The Reserve Bank believes New Zealand's non-inflationary growth cannot exceed 3 percent without substantial productivity growth.

There is a widespread feeling in business and the wider community that every time the economy achieves momentum, the bank stomps on it by raising interest rates.

However, the Business Roundtable has said there is no evidence a more relaxed approach to inflation targeting would produce faster growth.

It warns that if inflation averaged 2.5 percent over a decade, the Consumer Price Index would rise 28 percent -- far short of the price stability goal the Reserve Bank is mandated to maintain.

Signing the PTA will confirm Dr Bollard, currently the Treasury Secretary, as the new Governor.

Comments from our readers

No comments yet