2. Literature review

Paul Krugman and Robin Wells in “Macroeconomics” (second edition) outline the consensus thinking in monetary policy theory. That is, in the long run, changes in the money supply do not affect real GDP or the interest rate, and ultimately, monetary policy is ineffectual in the long term. But in the short run, monetary policy can successfully address output–demand imbalance through monetary policy instruments, such as inflation targeting and the use of central banks’ power to affect interest rates.

Mr Alan Bollard, who was the Governor of the Reserve Bank of New Zealand until September 2012, wrote in that month for The Banker magazine in his article “New Zealand learns from the sidelines of the crisis”. On the whole, he subscribes to the above traditional view. “The crisis experience has raised questions around whether we can still rely on orthodox monetary policy to work in the traditional way. In New Zealand’s case, we think so”⁶.

Thomas I. Palley with the German Macroeconomic Policy Institute, challenges this view. His “Monetary Policy and Central Banking after the Crisis: The Implications of Rethinking Macroeconomic Theory.” states that “The financial crisis and the Great Recession have prompted a rethink of monetary policy and central banking… The insider reform makes no changes to macroeconomic theory and is uncritical of the central banks’ pas actions… The outsider program fundamentally challenges existing macroeconomic theory and is also highly critical of the central banks. They should have a duty to shape the allocation of credit and the financial system in ways that ensure growth, full employment and a fair shake for all”⁷. “The paper’s critique of existing monetary policy and central bank practice and it recommended reforms are focused on the US Federal Reserve. However, the principles that are articulated and many of the proposed reforms carry over to monetary policy and central banking everywhere, including the Bank of England and the European Central Bank”⁸. For the Reserve Bank of New Zealand, which has been following the traditional line of thinking, this means that it is also subject to the same criticism.

The Bank’s Board of Directors in its ”Explaining New Zealand’s Monetary Policy” naturally disagrees with such a radical proposal and states that “Growth in an economy is driven by many factors, most of which have nothing to do with monetary policy… Over the long run, an economy’s performance is ultimately determined by productivity… Employment is maximised by having the economy operate as productively as possible. Price stability can assist, but it is far from the only factor affecting employment. For example, educational standards, skill levels, labour laws, and social policies can all increase employment levels, and these things have nothing to do with the Bank’s operation of monetary policy”⁹. The Bank’s position is that its primary concern is as stated in the Reserve Bank of New Zealand Act 1989 – to maintain the price stability with low inflation.

The Board of Directors of the Reserve Bank of New Zealand had also agreed on the place and role of the Bank in a wider context, that is, in macro-prudential regulation. The Board thinks that “When selecting an appropriate instrument, an important consideration will be the effectiveness of the instrument in meeting the policy objectives given the particular risks facing the financial system at that time… In some cases, the optimum response might involve using more than one instrument…”¹⁰

Rebecca Jackson-Young (lead analyst) and Fung Siu (analyst) of the Economist Intelligence Unit have provided an outlook for the New Zealand Economy in their November 2013 overview of political, social and economic risk assessment for the country for the foreseeable future.

Alan S. Blinder, Michael Ehrmann, Marcel Fratzscher, Jakob De Haan and David-Jan Jansen of the European Central Bank in “Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence” maintain that on the whole, transparency and clarity in communication by the Central Banks could not only dispel public fear or misunderstanding of what central banks do and why they do it, but also make the monetary policy more effective¹¹. New Zealand is commented on by the ECB as an enthusiastic pioneer and an example to follow.

The Reserve Bank of New Zealand Act 1989 governs the activities of the Reserve Bank through legal provisions. They concern different areas, such as the purpose – to establish that the Reserve Bank of New Zealand (RBNZ) has the overall responsibility for monetary policy, maintenance of a sound and efficient financial system, and carrying out other functions, appropriate to the nation’s Central Bank¹². The Act also defines the principal terminology, the internal structure of the Bank, the role of officials and such functions such as the principal executor of the monetary policy, regulator in the macroeconomic area, foreign exchange, issuing of currency, and banking supervision.

The official data and announcements from the Reserve Bank of New Zealand, such as Monetary Policy Statements and supporting downloads on the website provide first-hand information on New Zealand economy and its main indicators over historically significant period of time, of which five such announcements are covered in the paper. Graphical support, prepared by the author of this paper, enable better visualization of economic trends in the country over the last ten years.