RBNZ "incredibly determined" to get inflation back to target

The pandemic, the Ukraine war and recent floods have all impacted the NZ economy, expert says

RBNZ "incredibly determined" to get inflation back to target

Reserve Bank of New Zealand Chief Economist Paul Conway (pictured above) said RBNZ is “incredibly determined” to bring inflation and inflation expectations back to the 1% to 3% target.

Annual consumer price inflation currently sits at 7.2%, which is around the highest it has been since the late 1980s.

In a speech at the ANZ-KangaNews New Zealand Capital Market Forum in Wellington, Conway said the monetary policy committee has been hiking the OCR to bring demand back into balance with the reduced supply capacity of the economy, which over recent years has been dramatically constrained by the COVID-19 pandemic, Ukraine war, and the recent domestic cyclone.

Conway covered three key areas in his speech – why inflation is currently high, the factors affecting the outlook for inflation, and what the monetary policy committee is doing about it. 

“Higher interest rates reduce demand by encouraging people to spend less and save more, which reduces inflation pressure in the economy,” Conway said. “As in many countries around the world, we expect this monetary policy tightening to cause the New Zealand economy to enter a mild recession later this year as demand slows. 

“However, the depth and persistence of any recession depends on peoples’ behaviour. The more that businesses and workers absorb cost increases in their real profit margins and real wages respectively, the less monetary policy will need to tighten, and the sooner inflation pressures will ease. The converse applies.”

Conway imparted four key messages in his speech.

Inflation is high and widespread. Inflation has become widespread and persistent due to strong demand outstripping supply, businesses passing on higher costs, and workers seeking higher pay to compensate for higher prices. Fiscal and monetary responses to the pandemic supported demand while health measures and other shocks worsened the supply of products and labour.  

NZ is worse off because of the pandemic, the war, and floods. There’s nothing monetary policy can do to make up for the loss of real income stemming from these events.  

Monetary policy is lowering inflation. RBNZ is lifting interest rates to bring inflation and inflation expectations back to the 1% to 3% target.  

Bringing inflation back to target could be made more difficult. The task of taming inflation could be tougher if businesses and workers try to push up their real profit margins and real wages to make up for the inflationary impact of the recent pandemic, war, and storms.

“That would mean monetary policy would need to be more contractionary for longer and a deeper recession would result,” Conway said.

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