Below is a very good video from the Reserve Bank of New Zealand outlining how the Official Cash Rate (the key rate of the Central bank) works in maintaining price stability. This is part of the Internal Assessment for NCEA Level 2. Remember the following:
Reserve Bank Act 1989 – made price stability the sole aim of monetary policy.
- The RBNZ, who implements monetary policy, was made responsible for keeping prices “stable”.
- “Price Stability” is defined in the Policy Target Agreement (PTA) as keeping the inflation rate between 1 and 3%.
- “Inflation” is measured by the percentage change in the Consumer Price Index (CPI). Statistics NZ calculates the CPI.
Congratulations to Martin Luk (Governor), Amanda Ngo, Jake McConnell, Shaan Keesha and Amay Aggarwal who won the Reserve Bank of New Zealand Monetary Policy Competition. The team made a 10 minute presentation on their OCR decision to three RBNZ economists Jed Armstrong and Hayden Skilling, and Assistant Governor John McDermott. They then had a 20 minute question and answer session in which they showed great teamwork in answering some very searching questions. There were 5 other schools in the national final.
From the BNZ Economy Watch.
In the Post-GFC environment, heightened bank funding costs have driven a wedge between the OCR and borrowing costs. The key contributor has been RBNZ regulation requiring banks to source more secure forms of funding. Some relief in costs was experienced last year as some expensive funding from the GFC rolled off, and some reduced competition in the domestic deposit market was experienced. At the margin there is potential for a little further decline in funding costs. However, greater stability is now expected. Therefore more of the rise the underlying OCR will ultimately be felt by borrowers.
Although the Ides of March refer to the 15th March, the next Monetary Policy Statement from the Reserve Bank Governor is on the 13th March and most commentators believe that this will be the first of many hikes that will see the OCR hit 4.5% by late 2015. There was a belief that RBNZ Governor Graeme Wheeler would start hiking last week but central banks don’t like giving exact dates. But the Christchurch rebuild and the increase in Auckland house prices will warrant higher costs of borrowing
Central Banks have often used the term ‘the neutral rate’ which refers to a rate of interest that neither stimulates the economy nor restrains economic growth. This rate is often defined as the rate which is consistent with full employment, trend growth, and stable prices – an economy where neither expansionary nor contractionary measures need to be implemented. In most economies post GFC the neutral rate of interest fell as they have required lower rates to try and encourage growth. The graph from the BNZ below shows that the neutral rate in NZ has dropped form 6% to 4.5%.
The BNZ Markets Outlook looked at reasons why Graeme Wheeler, the RBNZ Governor, might keep a ‘steady as she goes’ attitude to Thursday’s OCR review. Below are some thoughts as to why he could be swayed to increase or decrease the OCR rate.
With all that said it is expected that Graeme Wheeler will leave the OCR unchanged at 2.5%.
Figures out today show that the unemployment rate increased by 0.5% from the previous quarter to 7.3% – see ASB Bank graph.. This was a concern considering the market expectation was a reduction of 0.1% to 6.7%. The main fall was in Auckland where employment fell by 2% and this should mean that new Reserve Bank Governor Graeme Wheeler will hold off on any increase until late next year. A reduction in the OCR is unlikely unless there is further deterioration on overseas markets.
Remember the types of unemployment
Frictional – The unemployment that inevitably results from the process of job-seeking. It will exist under conditions of generally so-called full-employment conditions (see employment, full), but it is not precisely clear what proportion of total unemployment can be called frictional.
Structural – Unemployment arising from changes in demand or technology which lead to an oversupply of labour with particular skills or in particular locations. Structural unemployment does not result from an overall deficiency of demand and therefore cannot be cured by reflation, but only by retraining or relocation of the affected work-force, some of which may find work at low wages in unskilled occupations.
Cyclical – Demand-deficient unemployment occurs when there is not enough demand to employ all those who want to work. It is a type that Keynesian economists focus on particularly, as they believe it happens when there is a disequilibrium in the economy.
Seasonal – Some workers, such as construction workers or workers in the tourist industry, tend to work on a seasonal basis. Seasonal unemployment tends to rise in winter when some these workers will be laid off, whilst unemploymnet falls is summer when they are taken on again.
Today Alan Bollard, Governor of the Reserve Bank of New Zealand, unsurprisingly kept the Official Cash Rate at 2.5%. One area of concern in today’s statement was the NZ dollar – the RBNZ would prefer to see it a lower levels (see notes below on advantages and disadvantages of a strong dollar). Therefore the future direction of NZ dollar will be critical to interest rate decisions. The bank did suggest that they would hold off on rises with the sustained strength of the NZ dollar.
The Output Gap
The output gap refers to the difference between potential GDP and actual GDP or actual output. According to the BNZ the Treasury produced three estimates of the output gap using various filtering techniques. They were all close to zero, with one slightly abovevand two slightly below. If this is where the true output gap currently sits, it means there is little spare capacity in the economy. So, any reasonable growth is likely to lead to inflationary pressure before too long. It could yet turn out that the RBNZ does not have that much time up its sleeve, before medium term inflation pressures emerge. That though, is likely to be a story for later in the year.
Advantages of a Strong Dollar
• A high NZ$ leads to lower import prices – this boosts the real living standards of consumers at least in the short run – for example an increase in the real purchasing power of NZ residents when traveling overseas
• When the NZ$ is strong, it is cheaper to import raw materials, components and capital inputs – good news for businesses that rely on imported components or who are wishing to increase their investment of new technology from overseas countries. A fall in import prices has the effect of causing an outward shift in the short run aggregate supply curve
• A strong exchange rate helps to control inflation because domestic producers face stiffer international competition from cheaper imports and will look to cut their costs accordingly. Cheaper prices of imported foodstuffs and beverages will also have a negative effect on the rate of consumer price inflation.
Disadvantages of a Strong Dollar
• Cheaper imports leads to rising import penetration and a larger trade deficit e.g. the increasing deficit in goods in the NZ balance of payments in 2001
• Exporters lose price competitiveness and market share – this can damage profits and employment in some sectors. Manufacturing industry suffered a steep recession in 2001 partly because of the continued strength of the NZ$, leading to many job losses and a sharp contraction in real capital investment spending and the lowest profit margins in manufacturing industry for over a decade
• If exports fall, this has a negative impact on economic growth. Some regions of the economy are affected by this more than others. The rural areas are affected by a strong dollar in that our produce becomes more expensive to overseas buyers.