What Is Monetary Policy?

Today, the Reserve Bank uses monetary policy to control inflation and keep it
within a specific target band. Monetary policy is encountered by ordinary New Zealanders in several ways. New Zealanders directly encounter the main instrument of monetary policy, the Official Cash Rate (OCR), when they borrow money at retail interest rates through mortgages, credit cards or personal loans, or when they save money in bank accounts that earn interest. Retail rates of interest are directly related to the OCR set by the Reserve Bank. Other ways that New Zealanders encounter monetary policy are through its effect on inflation and economic activity. Since the late 1980s, monetary policy has contained inflation within narrow limits – so effectively, in fact, that we forget that just a generation ago it was thought normal to have annual price rises of 16 or more percent. Monetary policy also helps prevent large swings in economic growth and employment.

Today, the Reserve Bank uses monetary policy to control inflation and keep it
within a specific target band. Monetary policy is encountered by ordinary New Zealanders in several ways. New Zealanders directly encounter the main instrument of monetary policy, the Official Cash Rate (OCR), when they borrow money at retail interest rates through mortgages, credit cards or personal loans, or when they save money in bank accounts that earn interest. Retail rates of interest are directly related to the OCR set by the Reserve Bank. Other ways that New Zealanders encounter monetary policy are through its effect on inflation and economic activity. Since the late 1980s, monetary policy has contained inflation within narrow limits – so effectively, in fact, that we forget that just a generation ago it was thought normal to have annual price rises of 16 or more percent. Monetary policy also helps prevent large swings in economic growth and employment.

 

Developments in monetary policy

 

Monetary policy aims and methods have changed over time. In the mid-20th century, a period when government regulations played a significant part in the economy, the Reserve Bank was instructed to use monetary policy to enhance growth, reduce unemployment, and keep prices stable.

 

At the time, this was a largely administrative exercise. The exchange rate was fixed between 1949 and 1967, and there were no financial markets in the modern sense. However, the effort was not particularly successful, partly because the policy tools the Reserve Bank had to work with were not well suited for such a wide range of tasks.

 

Inflation targeting was a response to the experience of the 1960s and 1970s.
New Zealand, like most western nations, suffered from high inflation from the late
1960s. Government efforts to reduce it by regulation were not effective, but both
research and practical experience overseas indicated that inflation could be reduced
by controlling the money supply. Inflation control by the central bank has historical precedent. As early as the 1690s, the Bank of England was charged with maintaining the value of coinage, albeit in an economy that differed significantly from the modern one. In the 1930s, the Swedish Rijksbank set price stabilisation as a goal of monetary policy. This was price-level targeting rather than inflation control, but it has been argued that this helped the Swedish economy weather the worldwide depression of the day. At times in the past, the Reserve Bank of New Zealand was also instructed
to keep prices under control, albeit as one of a wider – and not always compatible
– range of monetary policy goals.

 

The worldwide trend to liberalise during the early 1980s – and the emergence of financial markets – made new avenues of inflation control possible. New Zealand’s own period of liberalisation, in the mid-to-late1980s, thus effectively opened the way for inflation-control policies. A general drive to control inflation was fairly standard in western economies by this time, but in 1989/90 New Zealand pioneered a further monetary policy step – a specific target band.

 

Today, this style of inflation targeting is shared with a number of significant economies worldwide, including Canada, the United Kingdom, Norway, Poland,
South Africa, Sweden, Australia and the Eurozone.

Further details of New Zealand’s economic history and the Reserve Bank’s role are published in the brochure The Reserve Bank and the Economy.

 

 

. "Reserve Bank of New Zealand." . . Reserve Bank of New Zealand. 1.31.08 <http://www.rbnz.govt.nz/>.