RBNZ Says Pandemic Inflation Taught It Lessons For Future Shocks

New Zealand’s central bank has learned lessons from the post-pandemic bout of fast inflation and is now better placed to respond to future shocks, chief economist Paul Conway said.

The Reserve Bank’s Monetary Policy Committee has gained valuable insights into how economic activity, price setting by businesses and inflation expectations evolve during periods of high inflation and economic volatility, Conway said Monday in Wellington after releasing a review of monetary policy in recent years.

“We now have a deeper understanding of supply shocks and structural drivers of inflation and have expanded our use of high-frequency data for more timely and granular monitoring,” he said. “We have developed new tools to estimate neutral interest rates and run scenario analysis. These improvements ensure the MPC is well equipped to navigate future shocks while maintaining price stability.”

The RBNZ faced criticism for keeping policy too loose in the wake of the pandemic, which fueled price pressures and required higher interest rates to return inflation to its 1-3% target band. The bank today laid some of the blame on its dual mandate at the time — since removed — which required it to protect the labor market as well as contain inflation.

“In hindsight, an earlier or more aggressive tightening might have reduced inflation sooner,” Conway said. “But this would have been difficult given the data available at the time and could have conflicted with the MPC’s mandate back then, which included maintaining maximum sustainable employment.”

The RBNZ’s forecast errors increased significantly during the Covid-19 period between February 2020 and August 2022, primarily due to large and unusual shocks, today’s research said.

However, large forecast errors were also experienced by private forecasters and other central banks during that period, and since November 2022 “our forecasting performance has improved to near pre-Covid-19 levels,” it said.

The RBNZ said the economic effects of the government’s large, rapid fiscal easing during the pandemic were underestimated and it has taken steps to improve its understanding of the impact of fiscal policy and to enhance its relationship with the Treasury Department.

It has also taken steps to maintain and strengthen its operational readiness for alternative policy tools when needed, including large-scale asset purchases and a negative cash rate.

“Over the past two decades, neutral interest rates have declined significantly, both in New Zealand and globally,” the RBNZ said. “This structural shift increases the likelihood that the OCR could reach its effective lower bound in future downturns; a situation where conventional monetary policy alone may be insufficient to stabilize inflation.”

As of late 2021, all major banks in New Zealand are technically and operationally ready to support a negative OCR if required, the RBNZ said.

Source: Bloomberg Europe