Global economic researcher Capital Economics warns against any move to put a time limit on the RBNZ achieving its inflation target

Independent global economic researcher Capital Economics (CE) is seeing irony in the new Government's move to "take the Reserve Bank of New Zealand (RBNZ) back to the past".

CE's head of Asia Pacific Marcel Thieliant says he doubts the imminent removal of the RBNZ's employment objective from the monetary policy mandate - to focus on a single target of inflation - would make much difference to economic outcomes. 

However, he does warn that any decision to force the RBNZ to achieve its inflation target within too short a period of time "could cause unnecessary swings in output when inflation is being buffeted by supply shocks".

The idea of a time limit on inflation is included in the coalition agreements, as it having another look at going back to the single decision maker role on OCR decisions as was formerly the case before the RBNZ's Monetary Policy Committee was set up.

While both options are set to be looked at by the Government in the New Year after the receipt of advice, it's not at this stage seen as likely that either would be pushed forward.

"It is rather ironic," Thieliant says, "that at the same time that Australia’s government is tabling legislation to modernise the Reserve Bank of Australia in response to the recent review, New Zealand’s newly-elected government intends to take the Reserve Bank of New Zealand back to the past."

He does say that at first glance, the track record of the RBNZ in terms of meeting its inflation target has become worse since the changes to its institutional framework in 2019.

"Whereas average inflation was close to the midpoint of the RBNZ’s target between 2003 and 2018, it has been twice as high since 2019," he says.

"In practice though, we doubt that the removal of the employment objective alone nor returning decision-making solely to the Governor would make much difference to the performance of New Zealand’s economy.

"For one thing, inflation has been well above target in nearly every advanced economy over the last couple of years.

"And the experience from other countries is that solely focusing on inflation won’t necessarily improve the central banks’ ability to achieve price stability. As Table 1 [below] shows, there’s a broadly equal split among the RBNZ’s peers between those that have an employment target and those that don’t. (Note that the Bank of Canada and the Bank of England are tasked to “support” employment).

"Yet the country where average inflation has been the furthest above target both before and after the pandemic has been the UK even though the Bank of England is a pure inflation-targetter."

"Nor is there strong evidence that pure inflation-targeting central banks cause much larger swings in unemployment: the countries with the lowest as well as the highest variation in the unemployment rate both feature a central bank with an employment mandate, whereas swings in unemployment have been in the middle of the pack among countries with pure inflation-targeting central banks."

Thieliant says he does suspect that the NZ Government will eventually decide against requiring the RBNZ to meet its inflation target within a certain period of time.

"But if it presses ahead and opts for a short period (e.g. two years), that could make it more difficult for the Bank to respond to supply shocks.

"For example, if the Bank had been asked to return inflation to target within two years following the surge in energy prices caused by the Ukraine War, it would have had to lift interest rates even more aggressively than it already has, pushing the economy into recession and causing an even more pronounced rise in unemployment."