Reserve Bank gets more flexibility on inflation target

9.45am

New Reserve Bank Governor Alan Bollard was given more flexibility by Finance Minister Michael Cullen in meeting the bank's inflation target when they signed a new Policy Target Agreement (PTA) today.

The new agreement raises the bottom limit of the inflation target so that the bank is now aiming at a 1-3 per cent inflation band rather than the old 0-3 per cent range.

The agreement requires the bank to aim at that target "on average over the medium-term".

Dr Cullen said the most significant change to the PTA was that the bank was now required to take a forward looking, medium-term approach to achieving price stability.

That would give the bank more flexibility in deciding how it responded to shocks in the economy and inflation variations around the target.

"The Government's aim has always been to avoid unnecessary instability in output, interest rates and the exchange rate," Dr Cullen said.

That objective had been explicitly included in the PTA he signed with former governor Don Brash in 1999, but Dr Cullen has previously claimed that that requirement was ignored by Dr Brash, now the National Party spokesman on finance.

Dr Cullen said the new PTA would make it easier for the goal to be achieved.

Dr Bollard, who begins his new job on Monday, said the new PTA acknowledged the way monetary policy had, and would, evolve.

"As inflation expectations have become steadily anchored, so monetary policy has become more flexible, and this trend will continue."

When Dr Bollard was appointed last month, Dr Cullen said he wanted New Zealand's inflation targeting to move towards an Australian-style approach.

But this agreement stops some way short. The Reserve Bank of Australia is required to keep inflation in a 2-3 per cent bank over the business cycle.

Dr Bollard said the shift to an inflation target "on average over the medium-term" would allow the bank to avoid unnecessary instability in output, interest rates and the exchange rate.

"This helps economic growth, which we all agree, New Zealand needs, by enhancing predictability and confidence and, by that, savings and productive investment.

"The raising of the bottom of the band brings the overall target more in line with New Zealand's outcomes in recent years and those of other countries," Dr Bollard said.

But critics, including Dr Brash and acting governor Rod Carr, argue that allowing more flexibility on the target will do nothing to enhance growth. They say that the bank is already taking a flexible approach, as evidenced by the 2.5 per cent inflation rate over the past three years -- little different from Australia's rate.

WestpacTrust chief economist Adrian Orr, a former RB chief economist, said the move was aimed at allowing the bank to become more popular, rather than being more admired.

He said allowing more inflation did nothing to improve the economic growth rate.

Dr Bollard said in a letter of acceptance to Dr Cullen that he recognised the need for the bank to be independent of the Government while at the same time they needed to keep each other informed.

There was little reaction in the money market to today's changes. The New Zealand dollar was buying US47.05c by 9.10am, unmoved on its opening level.

- NZPA

Full text: Policy Targets Agreement