Monetary Policy

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Come one, come all!
Reserve Bank
Role of the Reserve Bank
Monetary policy (to follow in the next slides)
Check the financial system (what did happen to
Allan Hubbard?)
Financial market activities (buying and selling
government stock).
Clearing and settling services (eg overnight
interbank lending to settle bank transfers).
Banking system liquidity.
Supplying real money (notes and coins).
Monetary policy
Control of the interest rates.
To control the money supply.
To control the amount of credit available.
To ensure that inflation would stay between
1% and 3%.
Money supply
Reserve Bank Act 1989
Monetary policy, as set by the Reserve Bank,
has to ensure price stability.
1 3% inflation.
There is a Policy Target Agreement between
the Minister of Finance (Bill English) and the
Governor of the Reserve Bank (Alan Bollard).
The RBNZ acts independently of the
government of the day.
Stable prices
Why bother? The spectre of 1920s Germany
(and also Hungary, Yugoslavia, Brazil, and a
long list of countries).

Who is hurt?
Inflation
Theory
If there is inflation, NZ costs increase.
So the cost of NZ exports (to the rest of the
world) increases.
So NZ exports are less competitive.
Thus; low inflation
Means competitive exports
People can save (not spend)
Firms can invest in solid production
Wage & price spirals are avoided.
CPI
Inflation is measured with a basket of goods.

OCR
Official Cash Rate
In order to settle overnight bank transfers, the
banks rely on the Reserve Bank which sets the
minimum rate.
This influences the higher interest rates (prime
lending rate to established companies,
mortgage rates, rates to smaller companies,
rates to individuals, credit card rates etc).
Bank lending
When banks are restricted in their lending, (eg
increased interest rates),
Consumers & firms dont borrow. (Note this
has a negative effect on growth.)
So Aggregate Demand (Y = C + I + G + X M)
decreases.

So inflation pressure decreases (in theory
inflation goes down).
Interest rates
Trade effect: interest rates attract investment
from overseas.
When foreigners demand NZ$ this increases the
demand for $.
As a result, the exchange rate will increase.
E.g. NZ$1 = Aus 0.80 becomes Aus 0.90.
The NZ$1 apples sold in Australia for Aus$0.80
are now Aus$0.90.
So more expensive and less demand.

Exchange rates
An appreciation (increase) in the exchange rate
(eg, caused by an increase in the OCR) leads
To cheaper imports.
E.g NZ$1 = Aus$0.80 appreciates to Aus$0.90.
Means Aus$1 = NZ$1.25 depreciates to NZ$1.11.
An Australian rugby shirt, which costs Aus$100 to
make, previously sold for NZ$125
But now sells for NZ$111.11.
Cheaper to buy the import.