Monetary Policy Statement - rbnz.govt.nz · RESERVE BANK OF NEW ZEALAND: Monetary Policy Statement 1 ... with a substantial tax cut bolstering increases in real wages. The one-off

1RESERVE BANK OF NEW ZEALAND: Monetary Policy Statement

Monetary Policy Statement1

May 1998

This Statement is made pursuant to Section 15 of the Reserve Bank of New Zealand Act 1989.

Contents

1. Overview and policy assessment 2Table 1: Summary of economic projections 4

2. Explaining the Monetary Conditions Index 5

3. Demand influences 8

4. Meeting the demands 13

5. Inflation developments 14

6. Credit trends and developments 18

7. Uncertainties 21

Appendices:1. Chronology 232. Reserve Bank statements on monetary policy 243. Policy Targets Agreement 374. Summary tables 395. Notes for the tables 48

The text of this document is available on the Reserve Bank’s internet home page(address: http://www.rbnz.govt.nz).

ISSN 1170-4829

1 Projections finalised on 8 May 1998. Text finalised on 20 May 1998.

2 RESERVE BANK OF NEW ZEALAND: Monetary Policy Statement

Monetary conditions have now eased for sixconsecutive quarters as prospective inflationpressures have gradually dissipated. Monetaryconditions are projected to continue to ease untilaround mid-1999, albeit at a more modest pacethan over recent quarters. The more subduedpace of the projected easing reflects the manyuncertainties about the path of inflation overthe policy-relevant period, especially given therecent significant loosening in monetary con-ditions. A level of monetary conditions ofaround 350 on the Monetary Conditions Index(MCI) is now viewed as appropriate, a decreaseof 150 points from the index level announcedin the March Economic Projections.

The Bank’s near-term outlook for the econo-my is similar to that presented in March,including a subdued international outlook, weakworld commodity prices, and restrained domes-tic spending. Developments since March haveled to a slightly longer period over which theeconomy is projected to operate below capaci-ty. Increased business uncertainty, rising costsof capital, and reduced domestic demand ap-pear to be delaying long-term investment plans.Consumer spending intentions also appear tohave been set back by rising unemployment,weakening house price expectations, and a highhousehold debt burden.

Internationally, the largest adjustment to ourprojections since March has been the substan-tial downgrade of growth prospects in Japan.For most of the rest of Asia, the views of inter-national forecasters appear to be converging ona uniformly weak outlook. Outside of the Asianregion, European growth prospects have gen-erally improved, while for the United States andAustralia, growth is projected to continue at asteady pace. Overall, the near-term outlook fordemand in New Zealand’s major export mar-kets is expected to be relatively weak, butimproving beyond 1998.

Despite the subdued short-term outlook, eco-nomic activity is projected to pick up in thesecond half of 1998 and in 1999. Householddisposable income trends remain favourable,with a substantial tax cut bolstering increases

in real wages. The one-off gains from the de-mutualisation of AMP and the announced tariffcuts are also likely to stimulate consumer spend-ing. Simultaneously, the significantdepreciation of the New Zealand dollar hasgreatly enhanced the competitiveness of NewZealand exports, and will be coupled with apick-up in international demand in 1999. Theexpansionary stance of fiscal policy, as well asthe easing in the stance of monetary policy overthe past year or so, are both expected to boostactivity. Overall, economic activity is project-ed to accelerate over 1999, with the economyexpected to have absorbed any spare capacityby late that year.

Several factors, such as the removal of tariffson motor cars and weaker world oil prices, areexpected to temporarily lower measured CPIinflation over 1998 and into 1999. Around mid-1999, inflation is expected to return to itsunderlying trend as these temporary effects dropout. As the forecast recovery continues, do-mestic price pressures can also be expected toemerge. It is in anticipation of these factorsthat monetary conditions are projected to be-gin tightening, albeit modestly, from mid-1999onward.

Considerable uncertainties remain with theseprojections. Stronger inflation could be expect-ed in the short term if importer margins ceasedeclining, or if world prices are not as subduedas expected. Households may also respondmore positively than forecast to the forthcom-ing tax cuts and AMP demutualisation. Theseuncertainties could be offset by a weaker out-look for the global economy, especially in theUnited States and Australia, as well as moresubdued domestic consumption if the housingmarket turns down more sharply than allowedfor. It is precisely because of uncertainties suchas these that monetary policy aims for inflationoutcomes near the centre of the target range.

1. Overview and policy assessment

Donald T BrashGovernor


Figure 1Consumer price inflation(annual percentage change)

Figure 2Nominal monetary conditions(December 1996 quarter average = 1000)

0

1

2

3

4

5

0

1

2

3

4

5Target range

May 1998 CPIX

March 1998 CPIX

Underlying inflation

% %

Projection

1992 20001999199819971996199519941993Calendar years

-500

0

500

1000

-500

0

500

1000May 1998 nominal MCI

March 1998 nominal MCI

Index Index

Projection

19961995199419931992 1997 1998 1999 2000Calendar years


Table 1Summary of economic projections(Annual percentage changes, unless specified otherwise)

Actuals ProjectionsMarch year 1997 1998e 1999 2000 2001

Price measuresCPIX 2.0 1.7 1.4 1.8 1.5

Wages 4.0 2.9 2.8 2.9 2.8Import prices -4.6 6.5 1.6 -1.9 -1.8Export prices -6.3 5.5 4.9 0.1 -2.0

Monetary conditionsNominal MCI (March quarter level) 956 550 225 225 45090-day rate (March quarter level) 7.5 8.9 8.0 6.8 7.5TWI (March quarter level) 68.4 61.2 58.5 59.8 61.8

OutputGDP (production) 1.6 2.7 3.0 4.3 2.9GDP (production, year average) 2.7 2.5 2.2 4.0 3.5Output gap (year average) 0.8 -0.4 -1.7 -0.3 0.7

Key balancesGovernment operating balance (% of GDP) 2.0 2.7 1.4 1.7 2.3Current account balance (% of GDP) -4.7 -8.2 -7.8 -5.8 -5.5Terms of Trade (year average) -0.9 -1.4 1.7 2.9 0.3Unemployment rate (year average level) 6.2 6.8 7.5 6.8 5.9Household savings rate (year average level) 1.4 1.0 3.2 3.5 3.4

World economyIndustrial production (year average) 2.5 3.7 1.3 3.4 2.8World CPI inflation 2.3 2.6 1.7 2.2 2.2

Quarterly projections Dec-97 Mar-98 Jun-98 Sep-98 Dec-98(quarterly percentage changes, unless specified otherwise)

CPIX 0.5 0.3 0.2 0.4 0.4Nominal MCI (level) 656 550 375 350 275GDP (production, seasonally adjusted) 0.5 0.2 0.4 0.7 1.0

e = estimate


Gauging the overall stance ofmonetary policyIn New Zealand, monetary policy affects eco-nomic activity and inflation through bothinterest rates and the exchange rate. This istypical of any economy whose financial mar-kets are open to the world. Movements indomestic interest rates and the exchange ratewill be closely intertwined and linked to cur-rent and prospective interest rate developmentsabroad. Moreover, with the economy open tointernational trade, movements in both interestrates and the exchange rate will affect economicactivity and inflation.

For many purposes, it is useful to consider theinterest rate and exchange rate channels ofmonetary policy separately. The Bank’s pro-jections, for example, are based on explicittracks for interest rates and the trade-weightedexchange rate (TWI). The particular tracksshown, however, represent just one possiblecombination out of many that would be con-sistent with achieving the Bank’s inflationtarget. The particular combination of interestrates and the exchange rate which eventuatesis determined in financial markets, both hereand abroad, and will reflect new informationand shifting assessments regarding the outlookfor the New Zealand and world economies.

To help judge whether different combinationsof interest rates and the exchange rate are con-sistent with achieving the inflation target,particularly in the periods between the Bank’spublished economic projections, it is useful tohave a summary measure of the overall stanceof monetary policy. This is what the MonetaryConditions Index (MCI) provides. The MCIalso provides a means of signalling the Bank’sview of the appropriate stance of policy, butwithout taking a specific view on either inter-est rates or the exchange rate.

There are a number of possible ways of con-structing an MCI. The Bank’s MCI weightsinterest rate and exchange rate movements inproportion to their estimated average effects onspending in the economy. A lower exchange

rate will tend to stimulate export demand andredirect spending away from imports and to-wards domestic goods and services, while lowerinterest rates will tend to stimulate consumerand business spending. These effects on spend-ing are regarded as being the most importantfor changes in the medium-term outlook forinflation. The MCI, therefore, does not takeinto account the more direct, but essentiallyshort-term, impact on the CPI inflation rate ofchanges in the exchange rate or interest rates.

The Bank estimates that, on average, a 100 ba-sis point movement in ‘real’ interest rates hasapproximately twice the impact on aggregateeconomic activity as a 1 percent change in the‘real’ exchange rate.2 On this basis, the MCI isconstructed as a 2:1 weighted sum of interestrate and exchange rate changes. This 2:1 ratiois slightly lower than is found in a number ofother relatively open economies, such as Aus-tralia, Canada, and Sweden, reflecting arelatively smaller sensitivity of activity to ex-change rate movements in those countries.

The 2:1 ratio is by no means precise. Theeconometric estimates that the ratio is based onare subject to uncertainty, and results vary ac-cording to the estimation method, sampleperiod, and so on. Moreover, it is recognisedthat even if the 2:1 ratio is reasonable on aver-age, the correct ratio may well vary over thecourse of a business cycle.

Concerns have been expressed that the use ofthe TWI measure of the exchange rate in theMCI may be misleading insofar as it does notallow for the sharp appreciation of the NewZealand dollar against several Asian currenciesover the past year. This issue was discussed inthe March Economic Projections. Of course,the same type of question can be raised withregard to interest rates. For example, the useof the 90-day bank bill rate in the MCI mayalso be misleading to the extent that a rising

2. Explaining the Monetary Conditions Index

2 ‘Real’ interest rates are defined as nominal interest ratesadjusted for recent or expected inflation, while the ‘real’exchange rate is defined as the nominal exchange rateadjusted for inflation differentials between New Zealand andits major trading partners.


proportion of household mortgages are now atfixed, rather than floating, rates (see section 6).

Given these sorts of uncertainties about the pre-cision of the weights used in the MCI, it wouldnot be sensible for the Bank to try, throughouteach quarter, to hold actual monetary conditionsextremely close to the level indicated as appro-priate at the beginning of the quarter. Partlyfor this reason, the Bank has allowed consider-able scope for actual monetary conditions tovary in the period between projections.

The evolution of monetaryconditionsSince late 1996, monetary conditions, measuredin terms of the MCI, have eased progressivelyas pressures on medium-term inflation havewaned. In general, actual monetary conditionshave tended to fall below the level indicated inthe Bank’s quarterly projections as appropriatefor meeting the inflation target. On severaloccasions this has generated tension as marketshave tested the Bank’s tolerance of deviations,or as the Bank has sought to put the brakes onfurther easing of conditions.

The tendency for financial markets to ease con-ditions more rapidly than indicated in theBank’s projections stems largely from the factthat financial markets reassess the outlook forthe economy and monetary policy on a contin-uous basis, while the Bank makes a formalreassessment only quarterly. Consequently,markets are inevitably in the business of antic-ipating the Bank’s next policy move. In suchcircumstances, they will naturally take into ac-count the Bank’s own projections of thedirection that monetary conditions are likely tobe going over time. In addition, markets willadjust interest rates and the exchange rate onthe basis of new information on economic de-velopments, well before the Bank formallyincorporates this information into its quarterlyprojections.

Over the past year, new information on NewZealand’s external economic environment hasled to a progressive shading down of growth

and inflation prospects. Thus, markets havegenerally anticipated that the next step in mon-etary policy would be in the direction of easingconditions by more than had previously beenindicated. By and large, markets have correct-ly anticipated how the Bank’s projections andpolicy assessment would be affected by newinformation. Typically, therefore, the Bank’squarterly resets of desired monetary conditionshave involved catching up to where marketshave already moved actual monetary conditions(see Figure 3). This tendency for markets tosuccessfully anticipate the Bank’s reassessmentof appropriate conditions reflects the fact thatboth the Bank and the markets share essential-ly the same information, and that the Bank’scommitment and approach to inflation target-ing are transparent and well understood.

It should also be stressed that although the MCIis useful between projections, it does not obvi-ate the need for projections. The appropriatelevel of monetary conditions depends on theprospective extent of inflation pressures. Theseare influenced by short-term interest rates andthe exchange rate, but also by a host of otherfactors. The role of the projections is to takeaccount of all these factors. As these factorslead to a change in prospective inflation pres-sures, the appropriate level of monetaryconditions will also change.

Figure 3Actual and desired MCI

300

400

500

600

700

800

900

1000

1100

Oct-96 Jan-97 May-97 Aug-97 Dec-97 Mar-98300

400

500

600

700

800

900

1000

1100

Actual MCI

Desired MCI

Index Index


The mix of interest rates and theexchange rateSince October 1996, monetary conditions haveeased by more than 700 index points. Throughthe first part of the easing phase, which lasteduntil mid-1997, most of the 300 point easing ofconditions took place through declining short-term interest rates. In the period from earlyJuly 1997 through to early May this year, mon-etary conditions eased by a further 400 indexpoints or so. In contrast with the earlier peri-od, however, the easing of conditions involveda sharp fall in the TWI exchange rate (by over12 percent) together with a rise in short-terminterest rates (by a little over 200 basis points).Thus, for the full period from October 1996 toearly May this year, essentially all of the eas-ing of monetary conditions came about througha depreciation of the New Zealand dollar (seeFigure 4).

gence of the Asian financial crisis. The sharpdeterioration in East Asian economic prospectsraised the likelihood of a more pronouncedslowing of growth and inflation pressures in theNew Zealand economy. This, in turn, impliedthat monetary conditions in New Zealand werelikely to ease sooner and to a greater extent thanpreviously anticipated. This prospect, togeth-er with evidence of an increasing currentaccount deficit, raised financial market percep-tions of a near-term risk of a significantdepreciation of the New Zealand dollar. Withopen capital markets, the increased currencyrisk has been reflected in a widening of short-term interest rate differentials versus the UnitedStates and Australia. Such a widening in short-term interest rate differentials has been furthersupported by the Bank’s unwillingness to ac-commodate the speed of easing of monetaryconditions implied by the exchange rate depre-ciation. In due course, however, as marketsbegin to sense that the New Zealand dollar hastroughed, or is less likely to fall much further,interest rate differentials will tend to fall, lead-ing to lower New Zealand interest rates.

The marked shift in the mix of monetary con-ditions has, in the Bank’s view, shown the valueof using the MCI. Because monetary policyworks through both interest rates and the ex-change rate, the Bank could not take a view ofthe appropriate level of interest rates withoutalso considering what was happening to theexchange rate. Nor could it take a view of theappropriate level of the exchange rate withouttaking interest rate changes into account. TheMCI provides a simple and transparentmethod for taking both interest rates and theexchange rate into account, while keeping theBank and financial markets focused on the over-all level of conditions relevant to themedium-term inflation outlook.

56

58

60

62

64

66

68

70

Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-986.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

TWI (LHS)90-day Bank bill rate (RHS)

Index %

Weekly data

Figure 490-day interest rates and the TWI

The fact that a substantial portion of the easingof conditions has been in the form of currencydepreciation is perhaps not surprising. Muchof the firming of monetary conditions over the1993-96 period came through a marked appre-ciation of the New Zealand dollar, to a levelwell above any reasonable assessment of itslonger-term equilibrium value. Sooner or lat-er, a significant reversal of the earlier run-up inthe currency was, therefore, almost certain.

A key trigger for the slide in the currency, andthe pronounced shift in the mix of conditionssince July 1997, appears to have been the emer-


World outlook and exports

OverviewThe outlook for world growth remains weakover 1998, although a pick-up is anticipated in1999 and 2000. Prospects at the regional levelcontinue to be disparate. The Asian economiesare expected to struggle, with the outlook forJapan having deteriorated sharply in recentmonths. In contrast, the United States remainsbuoyant with growth rates that will keep theeconomy near capacity. The growth prospectsfor other key trading partners, such as Europeand Australia, also remain positive.

Our projection for exports reflects the cyclicalnature of world demand, resulting in lower ex-port growth over the near term, but a recoveryin exports over 1999 and 2000. Improved com-petitiveness resulting from the fall in the realexchange rate will also contribute to a morepositive outlook for exports, although growthprospects will vary across sectors.

World outlookBased on Consensus Forecasts, annual aver-age growth in a 14-country3 measure ofindustrial production is expected to slow from4 percent in 1997 to rates of around 1.4 and 3percent over calendar 1998 and 1999, respec-tively. Relative to the March EconomicProjections, these projections show a weakerenvironment for exports over the current year,but a more pronounced pick-up subsequently.

In forming our view of world growth, we havetaken the mean of the Consensus Forecasts ofindustrial production in 14 countries, rather thanthe subset of pessimists as in our December1997 and March 1998 projections.4 The previ-ous decision to use a subset of pessimists was

based on our view that events in Asia wouldlead to a significant deterioration in the worldoutlook, but that the speed of events would taketime to be incorporated fully into the averageview reported in Consensus Forecasts. It is nowreasonable to assume that international forecast-ers have all had sufficient time to adjust theirprojections.

On a regional basis, Japan has received the big-gest downgrade in economic prospects for1998. Industrial production is now expectedto decline by 3 percent during 1998 (a down-ward revision of 2 percentage points from theMarch Economic Projections). Weak consum-er and business confidence, linked to structuralconcerns about the economy, especially thebanking sector, are expected to curtail privatehousehold spending and constrain investment.In response to this negative outlook for Japan,the Japanese Government announced anotherstimulatory fiscal package in April. The effectsof this package remain uncertain. The outlookfor the bulk of the other Asian economies hasstabilised around a very weak profile. Overall,Consensus Forecasts did not project a rapidrecovery in the economies most affected, al-though they did expect to see moderate growthtowards the turn of the century.

Prospects for the rest of the world are positive.Growth in the United States remains strong,although mounting inflation pressures may pre-cipitate a tightening of monetary policy. Theconsensus projections are for the US economyto moderate over 1998. Similarly, the Austral-ian economy is projected to continue growingat, or near, its capacity, bolstered by consump-tion and business investment. However, theimpact of Asia is taking its toll on business con-fidence there, as has the recent labour unrest.The overall outlook for Europe is favourable,with uncertainties surrounding the monetaryunion starting to dissipate.

Export growthOver the coming year, export growth is pro-jected to deteriorate in the face of the weakerworld growth outlook. The worsening outlook

3. Demand influences

3 The 14-country measure comprises Australia, China, France,Germany, Hong Kong SAR, Indonesia, Italy, Japan,Malaysia, South Korea, Taiwan, Thailand, United Kingdom,and the United States.

4 The ‘pessimist’ subset was a simple arithmetic average ofthe three reputable forecasters projecting the lowest growthin each country.


for Japan, our second largest export market, isof particular concern. World prices are alsoprojected to remain weak over the coming year.

However, the outlook for export volumes be-yond the March 1999 year has been revised upslightly since the March Economic Projections,with annual growth rates over the years toMarch 2000 and 2001 expected to averagearound 5 percent (see Figure 5). The increasedgrowth reflects the more pronounced cyclicalupturn in world growth and the impact on ex-port competitiveness from the decline in the realexchange rate.

Figure 5Export growth and 14-countryindustrial production growth(annual average percentage change)

New Zealand’s terms of trade are projected toimprove modestly over the period, followingseveral years of deterioration. World prices ofexports are expected to remain relatively flatover the March 1999 year before rising mod-estly over the remainder of the period.However, the largest boost to the terms of tradecomes from subdued world import prices giv-en the projected slowdown in OECD industrialproduction.

Domestic Demand

OverviewDomestic demand conditions are expected toremain subdued over 1998 and into 1999, eventhough growth in household disposable incomeis boosted by tax cuts, rising real wages, andincreased liquidity from the AMP share listing.Consumer enthusiasm for spending will bedampened by the high level of household debtservicing, reduced asset price expectations(house prices in particular), and rising unem-ployment. Business investment is also expectedto be restrained over 1998, following a rise inthe cost of capital, reduced expected demand,and low business confidence. Throughout 1998and for most of 1999, demand is expected toremain below the economy’s productive capac-ity (see Figure 6), leading to further downwardpressure on inflation.

The outlook across various export sectors re-mains diverse. Exports to markets in the UnitedStates and Australia appear to be strong, so farunscathed by events in Asia. Discussions withNew Zealand exporters to Asia have suggestedthat they have been able to re-direct some oftheir exports to markets in Europe, the UnitedStates, and to new markets in Africa and theMiddle East. However, tourism receipts andthe exports of logs remain at risk. The down-turn in Japan is leading to subdued constructionactivity, which may dampen demand for for-estry exports. Similarly, tourism is expected tofall, with declining visitor numbers from Asiaexpected to more than offset increased arrivalsfrom the United States and Europe. This de-clining trend is projected to reverse toward theyear 2000.

-2

0

2

4

6

8

10

12

-2

0

2

4

6

8

10

12Exports

14-country industrial production

% %

Projection

Calendar years

1992 1993 1994 1995 1996 1997 1998 1999 2000

Figure 6Output gap(percent of potential GDP)

-4

-3

-2

-1

0

1

2

3

-4

-3

-2

-1

0

1

2

3

May 1998 Output gap

March 1998 Output gap

% %

Projection

Calendar years

200019991998199719961995199419931992


Beyond the March 1999 year, the outlook fordomestic spending is more positive. Improvedemployment growth, household incomes, andimproved export competitiveness will all bol-ster demand. Business investment is alsoprojected to pick up due to a rise in anticipateddemand and lower capital costs. As a result,by the end of 1999, excess capacity in the econ-omy should have largely dissipated.

Fiscal policyThe fiscal projections are based on the Gov-ernment’s May 1998 Budget, but modified toreflect differing views on the macroeconomicoutlook. We expect that fiscal policy will con-tinue to stimulate demand over the projectionperiod. The two main elements are:

• Tax cuts scheduled for July this year. Overthe first year, these cuts are expected to boosthousehold disposable incomes by around $1billion, or 1 percent of GDP.

• Spending initiatives, as announced in theGovernment’s 1996 Coalition Agreement,and signalled in the May Budget. Up to theFiscal year 2000, the Government has re-duced its spending intentions slightly, fromthe $5 billion announced in the CoalitionAgreement to $4.7 billion. However, we donot expect this to substantially reduce thedegree of fiscal pressure on inflation.

Other Budget announcements, such as the tar-iff reforms and further benefit changes, couldpotentially influence the timing and strength ofconsumption and investment. Overall, theGovernment operating balance is expected toaverage around 2 percent over the projectionperiod, similar to the outlook in the March Eco-nomic Projections (see Figure 7). The impactof fiscal policy on inflation depends on thechange in the stance of fiscal policy, rather thanthe level of spending or operating surplus. Assuch, the policies announced in the May Budg-et remain consistent with our view that fiscalpolicy will have a stimulatory, albeit diminish-ing, impact on demand, as well as a directimpact on measured inflation.

Figure 7The operating balance and net publicdebt(percent of GDP)

Household influencesAlthough the growth in disposable income re-mains steady over the projection period,household spending will be restrained over thenear term. The positive factors impacting onhousehold disposable income include the taxcuts and real wage growth, as well as the li-quidity effects of the AMP share listing.However, rising household debt levels, a weak-er labour market, and reduced asset priceexpectations (especially house prices) are ex-pected to constrain consumption growth tobelow that of disposable income. The net out-come is a projected rise in household savingsrates, which will assist in the reduction of thecurrent account deficit.

Household consumption growth remained rea-sonably robust over recent quarters, althoughmore subdued growth is expected during theremainder of 1998 and into 1999. However,timing issues will be significant, with spend-ing patterns likely to be influenced by the Julytax cuts, the recent removal of motor vehicletariffs, and the rise in household liquidity fromthe AMP share listing. These factors may tendto temporarily boost consumption and mask anunderlying weak trend.

Over 1999 and 2000, annual consumptiongrowth is expected to average around 2 per-cent, down considerably from the 4 to 5 percentgrowth rates averaged over recent years. Many

0

10

20

30

40

50

1993 1994 1995 1996 1997 1998 1999 2000 2001-2

-1

0

1

2

3

4%%

Projection

June years

Operating balance (RHS)Net public debt (LHS)


of the factors that underpinned the past strongconsumption growth have now dissipated. Thestimulatory factors included strong net migra-tion, rising house and asset price expectations,rapidly declining unemployment, and increas-ing disposable incomes. These factors led to astrong rise in perceived wealth and fuelled rap-id growth in credit, further boostingconsumption.

Developments in the housing market are espe-cially important for consumer confidence ashome equity is an important part of total wealthfor many New Zealanders. The average houseprice is expected to decline by around 3 per-cent over the December 1998 year, impactingnegatively on households’ wealth perceptionsand their appetite for debt (see section 6). Someof the key downward influences on house pric-es include low consumer confidence, high realmortgage interest rates and household debt lev-els, reduced net migration, and an abundantsupply of residential dwellings. Job uncertain-ty will be another factor moderatingconsumption, with projections for employmentgrowth subdued and the unemployment rateexpected to peak at 7.7 percent in the Decem-ber 1998 quarter, before falling gradually (seeFigure 8).

Figure 8Employment and unemployment

With the supply of residential properties rela-tively abundant, as a result of past stronginvestment, the outlook for residential construc-tion is also weak over the remainder of 1998.Beyond the near term, rising net migration,improved employment prospects, continuedgrowth in real disposable income, and a reduc-tion in the availability of residential propertiesshould result in renewed growth in residentialinvestment levels (see Figure 9).

Figure 9Residential investment and netmigration5

-2

0

2

4

6

5

6

7

8

9

10

11

Growth in employment (LHS)Unemployment rate (RHS)

annual average % % of labour force

Projection

Calendar years

1992 1994 199819971993 1995 1996 1999 2000

Business developmentsThe outlook for business investment has dete-riorated since the March Economic Projections.We now expect investment to evolve in a morecyclical fashion, that is, weaker over the shortterm but recovering into 1999 (see Figure 10).

Typically, investment expenditure tends to fol-low cyclical movements in the economy and isusually volatile. Investment during the Decem-ber quarter was very weak, suggesting that firmshave already cut back expenditure. Businesscontacts and leading indicators, such as cementsales and QSBO investment expectations, allsuggest that firms will defer investment during1998. Moreover, the costs of investment haverisen, with interest rates having increased overthe last quarter, and a falling exchange rate add-

700

800

900

1000

1100

1200

-6

-4

-2

0

2

4

6

Real residential investment (LHS)

Quarterly net migration (RHS)

000's

Projection

Calendar years

1992 1999199819951993 2000199719961994

$m (91/92 prices)

5 Net migration is the quarterly flow calculated on a working-age basis, seasonally adjusted.


ing to the cost of imported capital equipment.Overall, a strong bounce back in investment isunlikely over 1998.

Over 1999, however, investment is expected topick up. Three key factors contribute to thisoutlook:

• Domestic and export demand conditions areexpected to improve.

• The costs of investment are projected todecline, as interest rates fall and the ex-change rate stabilises.

• Firms will resume investment in order toincrease productivity and maintain compet-itiveness.

Figure 10Business investment(percent of GDP)

8

9

10

11

12

13

14

8

9

10

11

12

13

14

Business investment(excluding computers)

% %

Projection

Calendar years1992 1993 1994 1995 1996 1997 1998 1999 2000


A useful way of assessing the ability of an econ-omy to meet the demand for goods and servicesis to examine its ‘potential output’, defined asthe level of output an economy can supply with-out generating higher or lower inflation. Whenan economy is operating above its potential, orcapacity, it is said to have a positive output gap,and inflation can be expected to rise. Converse-ly, and relevant to this projection, when aneconomy is operating below its potential, orcapacity, it is said to have a negative output gapand inflation can be expected to decline. Fig-ure 11 highlights this broad relationshipbetween developments in the output gap andsubsequent inflation.

Figure 11Output gap and future inflationdevelopments

significantly the Bank’s view on the appropri-ate stance of monetary policy. The scale of anyrevision must be weighed against the long anduncertain lags that exist between demand andinflation developments, as well as the array ofsupporting evidence from actual price move-ments, labour and asset market developments,and the Bank’s indicator models of short-termdemand changes.

Although historical data enables us to estimatethe current level of potential output, in order todecide on the future path of monetary condi-tions, a projection of potential output is needed.In forming a view, the Bank projects the futurepath for the three components of potential out-put: the supply of labour, growth in the capitalstock (net investment), and technology devel-opments (productivity). Over this projectionperiod, potential output growth is expected toslow to an annual average of around 2.8 per-cent. The slowdown reflects primarily cyclicaldeclines in capital formation (investment) andemployment growth. Business investment, inparticular, is expected to be more subdued over1998 and into 1999, following several years ofrapid growth. Technological developments re-main a key source of potential output growth,with firms continuing to innovate.

4. Meeting the demands

6 See Conway P. and B. Hunt, (1997), ‘Estimating PotentialOutput: a semi-structural approach’, Reserve Bank of NewZealand Discussion Paper G97/9.

One concern with using the output gap approachto assess prospective inflation developments isthat potential output is not directly observableand must therefore be estimated from past de-velopments. The estimation is done statisticallyby decomposing production-based GDP into atrend (potential) and cyclical component. Thedeviation of actual GDP from its trend is usedas a measure of the output gap.6 Another prob-lem that arises from time to time, as with theDecember 1998 GDP release, is that officialstatistics are occasionally revised, altering thehistorical estimate of potential output. How-ever, data revisions alone are unlikely to alter

-4

-3

-2

-1

0

1

2

3

4

5

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5%

Calendar years86

%

87 88 89 90 91 92 93 94 95 96 97

Output gap (percent of potential GDP)(LHS)

Quarterly difference in CPIX inflation(1 year ahead) (RHS)


OverviewIn the year to March 1998, the CPI excludingCredit Services (CPIX) rose by 1.7 percent,slightly above the centre of the Bank’s inflationtarget range (see Figure 12). The outlook isfor inflation to remain within the middle partof the Bank’s target range. Three distinctfactors shape this inflation profile:

• In the short term, a number of specific pricedevelopments are expected to dampen CPIXinflation. These include weak house pric-es, the removal of passenger car tariffs, andlower world prices for some major imports(notably oil).

• The short-term inflation outlook is also af-fected, though in the opposite direction, bythe significant depreciation of the New Zea-land dollar, which will boost traded goodsand services price inflation.

• The medium-term inflation profile is influ-enced primarily by the outlook for demandpressures in the economy. The negativeoutput gap lasting through into 1999 willtend to exert a gradual downward pressureon price inflation, particularly in the non-tradeables sector. Upward pressures oninflation are projected to develop later asexcess demand conditions re-emerge be-yond 1999.

Figure 12Annual inflationMarch and May 1998 projections(annual percentage change)

The projection for inflation to remain withinthe middle part of the target range is largely areflection of the fact that our projections pro-vide for adjustments to monetary conditions.In the current situation, for example, the mostlikely scenario in the absence of any adjustmentto the stance of monetary policy would be for amuch more prolonged economic downturn anda consequent fall in the inflation rate towards,or through, the bottom of the target range. Inshort, our approach to the projections meansthat as inflation pressures increase or decrease,most of this will be reflected in variations inmonetary conditions rather than in the project-ed track for inflation.

In this projection the Monetary Conditions In-dex (MCI) is projected to decline from a levelof 350 for the September 1998 quarter, to a lowof 200 through most of calendar 1999. This isa slightly lower profile over most of the pro-jection period than contained in the MarchEconomic Projections, and reflects largely themore subdued outlook for activity and infla-tion pressures over the next year or so.

Recent inflationThe Consumer Price Index excluding CreditServices (CPIX) increased 0.3 percent over theMarch 1998 quarter, taking the annual infla-tion rate to 1.7 percent, up slightly from the 1.6percent recorded over the year to December1997. The March quarter outcome was slight-ly below our projection of 0.5 percent. Thedifference was largely a reflection of some ex-ceptional price movements during the quarterthat were not anticipated in our March projec-tions.

5. Inflation developments

0

1

2

3

4

5

0

1

2

3

4

5

May 1998 CPIX

March 1998 CPIX

Underlying inflation

% %

Calendar years

1992

.

1993 1994 1995 1996 1997 1998 1999 2000

Projection


In December 1997, the Governor of the ReserveBank and the Treasurer signed a new PolicyTargets Agreement (reproduced in Appendix 3).The new Policy Targets Agreement (PTA) de-fines the Bank’s target price index as the CPIX.At the same time, the Bank indicated that itwould cease calculation of its ‘official’ meas-ure of underlying inflation. This decision partlyreflected the fact that, in general, the main dif-ference between the CPI and the Bank’sunderlying inflation measure was the CreditServices component. An additional considera-tion was some discomfort with the Bankcalculating the benchmark measure of inflationagainst which the Bank’s performance isjudged.

Despite the decision to cease calculating theunderlying inflation series, the Bank underlinedits continuing commitment to account for in-flation outcomes and, in particular, fortemporary price disturbances that may distortor mask the on-going trend of inflation.

There are a number of different methods avail-able for distinguishing between the on-goingor ‘core’ inflation rate, and the effects of pricedisturbances that are likely to have only a tran-sient impact. A method commonly usedoverseas is to re-calculate the CPI after exclud-ing a range of prices that are considered to beparticularly volatile or prone to supply shocks.By excluding such prices, it is hoped that aclearer picture of the more general trend of in-

flation will emerge. The most common exclu-sions are fresh fruit and vegetable prices andenergy prices. The drawback with this approachis that transient shocks to the inflation rate cancome from a great many sources. Recent ex-amples in New Zealand have included airfareprice ‘wars’, cuts in government subsidies forpublic housing and education, tariff cuts, res-toration of child medical care subsidies, and soon.

An approach that allows for variations in thesource of transient inflation disturbances is toplace less weight on all extreme price changescompared to their standard weight in the CPI.The most common measures of this type –often described as ‘robust’ measures ofinflation – are the ‘weighted median’ andvarious kinds of ‘trimmed means’.

Table 2 shows inflation rates for the CPIX,tradeables and non-tradeables prices,7 the CPIXexcluding fresh fruit and vegetable prices andenergy prices (CPIX ex F&E), and three ‘ro-bust’ measures of the general trend of inflation:

• A 10 percent trimmed mean (Trim10), whichexcludes the top and bottom 10 percent ofprice changes in each quarter.

• A 1 standard deviation trimmed mean(TrimSD), which excludes all price chang-es more than 1 standard deviation above orbelow the mean (ie roughly the 15 percentmost extreme price changes).

• The weighted median (median), which is themiddle price change (ie half the prices inthe CPI, by regimen weight, rose by morethan the median price change, and half byless). 8

Figure 13CPIX inflation: tradeables &non-tradeables(annual percentage change)

-1

0

1

2

3

4

5

6

-1

0

1

2

3

4

5

6

CPIX

Tradeables

Non-tradeables

% %

1992

Calendar years

1993 1994 1995 1996 1997

7 ‘Tradeables’ refers to prices determined primarily ininternational markets, while ‘non-tradeables’ refers to pricesdetermined primarily in domestic markets.

8 See Roger S., (1995), ‘Measures of underlying inflation inNew Zealand, 1981-95’, Reserve Bank of New ZealandDiscussion Paper G95/5 and Roger S., (1997), ‘A robustmeasure of core inflation in New Zealand, 1949-96’, ReserveBank of New Zealand Discussion Paper G97/7.


Table 2Measures of consumer price inflationMarch quarter 1998

Percentage changesInflation March 98 March 98measure year quarter

CPIX 1.7 0.3Tradeables 0.4 0.1Non-tradeables 3.2 0.4CPIX ex F&E 1.6 0.0Trim10 1.7 0.3TrimSD 1.9 0.3Median 1.9 0.4

The figures in Table 2 suggest that:

• Non-tradeables price inflation continues tosubstantially outpace tradeables inflation,despite the depreciation of the New Zealanddollar over the past year (see Figure 13).Nonetheless, the 2.8 percentage point dif-ferential between these inflation rates hasnarrowed (from 3.8 percent in the secondhalf of 1997) as import price inflation picksup and domestic price pressures weaken.

• In the March 1998 quarter, fresh food andenergy prices, on balance, boosted the CPIXinflation rate. The impact of higher freshfruit and vegetable prices (up 11.1 percent)in the quarter, reflecting unusual weather (ElNiño), more than offset the impact of lowerpetrol prices (down 2.1 percent), boostingthe aggregate inflation rate by about 0.3percent in the quarter.

• Taking into account a wider range of rela-tive price disturbances, however, it appearsthat such shocks, on balance, slightly damp-ened the overall inflation rate during thequarter. More specifically, higher fresh pro-duce prices plus an increase in tertiaryeducation fees (up 8.7 percent) were morethan offset by the combined effect of lowerprices for petrol, international air travel(down 8.4 percent), and telephone toll charg-es (down 18.9 percent).

Overall, therefore, exceptional price changesover the past year have tended to dampen meas-ured inflation more than they have boosted it.The robust measures show a slightly higher in-flation rate than CPIX over the past year and inthe March 1998 quarter. However, all of themeasures of generalised inflation show infla-tion in the March 1998 year well within thetarget range. Figure 14 summarises the distri-bution of price changes for the March 1998quarter. It can be seen that the largest propor-tion of price changes (by regimen-weight) arepositive. However, some large price changesat both ends (tails) of the distribution also oc-curred.

Figure 14Distribution of annual price changes(March quarter 1998)

Inflation expectations are an important meas-ure of price pressures precisely because theytend to capture the persistent elements that willbe reflected in future or on-going inflation.9

Table 3 shows the results of four surveys ofinflation expectations for the year ahead, takenduring the March 1998 quarter. The differentsurveys show considerable dispersion of infla-tion expectations, with an average marginallyabove the core inflation measures shown inTable 2.

9 See Roger S., (1998), ‘Core inflation: concepts, uses andmeasurement’, Reserve Bank of New Zealand DiscussionPaper, forthcoming.

0

5

10

15

20

25

0

5

10

15

20

25

Annualised QuarterlyAnnual

< -

7.5

-7.5

to -

6.5

-6.5

to -

5.5

-5.5

to -

4.5

-4.5

to -

3.5

-3.5

to -

2.5

-2.5

to -

1.5

-1.5

to -

0.5

-0.5

to 0

.5

0.5

to 1

.5

1.5

to 2

.5

% of CPI regimen

Percentage change in price

6.5

to 7

.5

7.5

<

4.5

to 5

.5

2.5

to 3

.5

3.5

to 4

.5

5.5

to 6

.5


Table 3Year-ahead inflation expectationsMarch quarter 199810

Survey Expected inflationorganisation in year ahead

Reserve Bank of New Zealand 1.7%Aon Consulting 1.7%National Bank of New Zealand 2.4%Marketscope 4.0%

The inflation outlookCPIX inflation is estimated at 0.2 percent inthe June 1998 quarter, and 0.4 percent for theSeptember 1998 quarter. These quarterly in-creases would take the annual rate of inflationto 1.6 percent in the June year, and 1.3 percentin the September year. We have revised downour estimate for June by 0.3 percentage pointsfrom the March Economic Projections. The keyfactors accounting for this revision are:

• The recently-announced removal of passen-ger motor vehicle tariffs from mid-May.

• Our expectation that drought-induced in-creases in fruit and vegetable prices will bereversed.

• Petrol discounting following the entry ofChallenge! and the lower world price of oil.These influences are expected to be partial-ly offset by a lower exchange rate and thetwo cent per litre increase in excise tax onpetrol.

• A weaker outlook for house prices, whichinfluence our projection for the constructioncosts components of the CPIX.

Over the medium term, the inflation outlook islittle changed from the March Economic Pro-jections, despite being lower over the remainderof 1998. Initially, lower inflation is projectedbecause of a combination of lower fuel prices,a weak housing market, and the removal of tar-iffs on cars. The tariffs alone are estimated to

reduce annual inflation over the year to March1999 by 0.4 percent, with most of the impactfelt in the June 1998 and September 1998 quar-ters. In mid-1999, inflation picks up as thetemporary price adjustments run their course.The inflation profile rises briefly above the mid-point of the target range, peaking at 1.8 percentover the years to December 1999 and March2000, before returning to the mid-point by theend of the projection period.

Domestic inflation pressures are expected todecline slowly over most of the projection pe-riod, although non-tradeable inflation pressuresmay begin to re-emerge once the output gapturns positive at the end of 1999. Dampeneddemand over the first half of the projection pe-riod will be especially evident in the housingsector. There are signs that the recent modestdecline in house prices will continue. Our pro-jections include a further small fall in houseprices into early 1999.

Inflation in the prices of tradeable goods andservices will be affected by both the exchangerate and external demand. OECD industrialproduction growth is expected to decline overcalendar 1998 in the wake of the continuingAsian crisis. Reduced demand from these coun-tries will lower world prices and provide anoffset to the effect of the lower exchange rateon domestic currency prices. Oil prices havefallen to quite low levels, although we expectthey will return to around US$16 to US$17 perbarrel by the middle of next year. Inflation inthe tradeables sector will be further dampenedby importers lowering their margins in responseto weak demand.

10 The Reserve Bank of New Zealand conducts a survey ofselected sectoral experts, Aon Consulting surveys localeconomists, the National Bank of New Zealand surveysbusiness clients, and Marketscope surveys households.


OverviewDevelopments in financial market intermedia-tion provide an important source of informationregarding the state of the economy and futureinflation trends. For example, a rapid rise incredit demand may represent a future inflationrisk if it enables spending to rise ahead of theeconomy’s capacity to supply. Too rapid cred-it expansion may influence inflation eitherdirectly, as domestic production is stretched, orindirectly, as the result of a balance of paymentsdeterioration and a consequent depreciation inthe exchange rate.

In recent years, there has been a strong rise incredit demand from households, primarily forthe purchase of residential properties. To helpmeet this demand, domestic financial interme-diaries have obtained funding from foreigninvestors, who found yields in New Zealanddollar (NZD) financial assets attractive. Overthe projection period, these trends are likely tounwind as households reassess their debt lev-els, investors’ appetite for NZD exposure isreduced, and the housing market proves lesscredit-worthy. Signs of these developments arealready evident.

Corporate sector borrowing has lagged behindthat of household borrowing over the cycle.Since its peak in 1996, the growth in corporateborrowing has slowed. However, as the pros-pects for investment improve over 1999 andinto 2000, New Zealand businesses will be wellplaced with solid cash-flows to increase theirexposure to debt-financed investment.

Household credit developmentsand prospectsAn outstanding feature of the recent credit cy-cle has been the strength of growth in credit tothe household sector. A number of factors havecontributed to this (see Figure 15).

First, household confidence improved follow-ing a prolonged period of economicrestructuring and the recession in the early1990s. This was reflected in increased spend-

ing on credit-financed ‘big ticket’ items, likehouses and cars. Population growth, boostedby immigration, also contributed to increaseddemand for mortgage credit.

Second, there was a strategic shift of emphasisby the largest banks toward household lending,as they successfully re-oriented their systemsand skills towards profitable residential mort-gage lending. This shift was driven in part byloan-loss experiences on business lending dur-ing the late 1980s and narrowing margins onprime corporate lending.

Third, a change in industry practice allowedmore small business lending to be secured byhome mortgages. An unknown proportion oflending secured on residential property (prob-ably under 10 percent) is effectively lending tobusiness.

Figure 15Household and private sector creditgrowth11

(annual percentage change)

6. Credit trends and developments

0

2

4

6

8

10

12

14

16

18

0

2

4

6

8

10

12

14

16

18

Private sector credit(includes household credit)

Household credit

% %

Calendar years

199719961995199419931992

Fourth, innovative practices like mobile mort-gage lenders and lending by phone, and theentry to the housing loan market of new lend-ers, have created low cost means of distributingloan products, with competition rapidly narrow-ing costs across the market.

Finally, with attractive New Zealand dollaryields, foreign investors have shown a strongappetite for New Zealand fixed-term financial

11 Household credit is total household claims of M3 institutions.


instruments, including securities issued by over-seas borrowers (so-called Euro-kiwi andSamurai issues). This has caused downwardpressure on fixed-term mortgage interest ratesat a time when short-term interest rates havebeen higher than longer-term rates. This lastfactor has encouraged a substantial shift by NewZealand household borrowers and lending in-stitutions away from floating rate loans to fixedrate term loans (see Table 4). There has alsobeen an increase in the net funding by non-res-idents to New Zealand banks and othersurveyed financial institutions.

Table 4Proportion of fixed and variable ratemortgages(share of major lenders’ portfolios, end ofAugust)

Fixed1 Variable1994 7% 93%1995 20% 80%1996 41% 59%1997 52% 48%1 Fixed rate mortgages include capped rate mortgages.

From 1994 to late 1997, the strong flow of fundsinto the housing market contributed to pressureon house prices, fuelling expectations of ongo-ing house price increases. Set against theseprospective price gains on a house, rather thanagainst the CPI, mortgage interest rates maynot have appeared high. Indeed, until quite re-cently the real cost of credit facing householdsexpecting house price rises has probably ap-peared low, or even negative (see Figure 16).

Just as a number of factors combined to createthe housing credit cycle, several now point tomore subdued conditions over the projectionperiod. Net migration is now close to zero andprojected to remain weak. Consumer confi-dence is low, and this is beginning to bereflected in weaker demand for credit fromhouseholds. The ratio of household debt-to-disposable income has climbed from relativelymodest levels of around 55 percent to around90 percent, a ratio approaching those of sever-al other industrialised economies, suggestingthe period of ‘catch up’ may now be ending (seeFigure 17).

12 Nominal first mortgage interest rate deflated by annual houseprice inflation. House price inflation is a Valuation NewZealand series.

13 Personal disposable income is from annual household incomeand outlay account data. Household debt is total householdclaims of M3 institutions.

Uncertainty about the economic outlook is alsolikely to cause lenders to be a little more cau-tious in extending credit. More recently, theentire mortgage interest rate structure (fixed andfloating) has moved up by about one-half toone percentage point compared to 1997. Im-portantly, house prices have begun to weaken,and have fallen in some markets. Finally, whilethe shift to fixed-rate lending to the householdsector has meant that monetary policy has lostsome of its immediate bite, when it does bite,its grip may last longer. Overall, we expect amoderate growth rate of net lending to house-holds for the remainder of 1998, probably inthe mid- to low-single digit range.

-6

-4

-2

0

2

4

6

8

10

12

14

16

-6

-4

-2

0

2

4

6

8

10

12

14

16

Real mortgage interest rate

% %

Calendar years199719961995199419931992

Figure 16Real mortgage interest rate12

Figure 17Household debt and personaldisposable income13

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70$billion $billion

Calendar years

1991 1992 1993 1994 1995 1996 1997

Personal disposable income

Household debt


Business credit developments andprospectsGrowth in lending to the business (includingfarming) and corporate markets has been lessrapid than for households over the cycle (seeFigure 18). Several reasons could account forthis.

First, businesses have been profitable and haveused retained earnings to fund a significant partof their expansion, not requiring major loans.Now, as activity slows, we might expect someincreased borrowing to finance accumulatingstocks and slower-paying debtors. This effectis unlikely to become evident in aggregate fi-nancial data, but banks have commentedpublicly on its influence in their loan portfoli-os. In general, business balance sheets are ingood shape to support a moderate increase inlevels of indebtedness, given the prospect ofaccelerating growth next year.

Second, farmers increased their borrowingstrongly until 1996, as dairy farming returnsand conversions, along with the knock-on ef-fect of the purchase of land for forestry, droveup prices for agricultural land. Since then farmprices have slipped, and borrowing has slowedmarkedly as the outlook for farm revenues hasworsened.

provide the issuers with ‘credit’ (and liquidity)support, but normally not direct funding. Alarge proportion of corporate sector borrowing(possibly as much as half) occurs through chan-nels outside those measured by the Bank’scredit aggregates, ie directly from abroad orthrough the domestic capital market. Thus,while the trend revealed by the private sectorcredit aggregates is believed to be representa-tive, credit data in the corporate market needsto be treated with caution.

In sum, although growth in net lending by do-mestic financial institutions to the business andcorporate sectors has been much slower thanhas lending to households, there have been fewreports of credit-worthy firms being unable toborrow. On the contrary, competition amonglending institutions for sound business lendingopportunities has been very keen, as attestedby the narrow lending margins in the market.

By contrast, some firms, particularly those ad-versely affected by the Asian crisis and/or thedrought, will have run up against credit con-straints. Indications are that lenders areexperiencing some, albeit modest, increase indebt servicing difficulties from what have beenhistorically low levels. Firms exporting to someEast Asian countries have found that buyershave experienced difficulties providing themwith letters of credit, which normally assure thatpayment will be made. Local banks, faced withuncertainty about these countries’ banking sys-tems, have also been reluctant to confirm lettersof credit. This will have been one of the fac-tors behind the down-turn in exports to EastAsian countries in the March quarter.

Looking ahead, the subdued outlook for eco-nomic activity, particularly investment, is likelyto see the rate of credit expansion to the busi-ness and corporate sectors remain moderate.However, business profitability is projected tobe reasonably sustained. Thus if, as expected,firms’ demand for credit picks up in 1999 andbeyond, the underlying cash-flows required tocover any increase in debt servicing will besufficient to sustain a future rise in investment.

Figure 18Household and business loans

20

30

40

50

60

70

20

30

40

50

60

70

Household loans

Business loans

$billion $billion

Calendar years

1994 19971995 1996

Third, corporate borrowers are increasingly tap-ping the funding markets directly, by issuingcommercial paper. Banks often support theseissues by acting as underwriters, and in this way


This section discusses the uncertainties sur-rounding the inflation projection over thepolicy-relevant period. Although projectedeconomic growth may still have some down-side risk, the uncertainties surrounding the fu-ture path of inflation are more balanced. Theinflation-restraining influences of possiblyweaker-than-projected output growth could beoutweighed by the effects of looser monetaryconditions and stimulatory fiscal policy, and theliquidity impacts from events such as the sharelisting of AMP. The uncertainty about higherinflation is especially relevant given the recentsignificant depreciation of the New Zealanddollar, which could flow through to tradeablesprices in particular, raising the inflation rate.

Lower inflation?Policy reforms and structural change in partic-ular industries are likely to temporarily affectinflation in the near term. These include chang-es affecting petrol retailing, excise taxes, tariffs,and the electricity sector. However, their ef-fects on prices are expected to be largelyone-off, and should have little influence on themedium-term inflation outlook. The mainsources of risk of lower inflation over the me-dium term derive from uncertainty about theworld economy, the difficulty exporters to EastAsia may experience in finding alternativemarkets, and the possibility that house pricesmay fall by more than expected.

World uncertaintiesA comparison of individual responses in theFebruary and April Consensus Forecasts sug-gests that views on East Asia are becoming lessdiverse, as they converge on a very weak out-look for a number of countries for 1998 and1999. The extent to which New Zealand cansustain exports overall will depend on devel-opments in New Zealand’s other tradingpartners, including Japan, Australia, and theUnited States.

Substantial downward revisions to Japanesegrowth in recent months highlight the uncer-tainties faced. Additionally, prospects for theUS economy are also increasingly uncertain,

with many commentators arguing that mount-ing inflation pressures could lead to aprogressive tightening in US monetary policy.In Australia, the impact of the Asian crisis isbeing felt more than was initially expected,which is raising some questions about whetherthe recent pace of domestic demand expansionin Australia will be sustained. In contrast, un-certainties about the prospects for Europe havebeen dissipating, now that it has been confirmedthat 11 countries will join the European Mone-tary Union, which is to take effect on 1 January1999. However, considerable uncertainty re-mains about how the single currency will affectthe individual performance of these economies.

Domestic economy uncertaintiesHousehold and business confidence is beingadversely affected by both the uncertain inter-national outlook and by signs that house priceshave the potential to fall significantly. ThisMonetary Policy Statement assumes that the fallin house prices will be moderate during 1998,and that house prices will be underpinned by afall in nominal interest rates during 1999. Ifthe fall in house prices were to be deeper andmore protracted than expected, consumer con-fidence could weaken further, and this wouldlikely outweigh the stimulatory effects of low-er interest rates. Overall, a weaker domesticspending profile would result, dampening in-flation pressures.

Higher inflation?Over the medium term, higher-than-expectedinflation might result from higher import-pricemargins and stronger-than-expected effectsfrom looser monetary conditions and the fiscalpolicy stimulus.

Import pricesThe March 1998 Economic Projections notedthe risk of higher inflation if the mix of mone-tary conditions continued to shift to a lowerexchange rate and a higher interest rate profile.In this Monetary Policy Statement, the lowerpath of the TWI exchange rate relative to theMarch Economic Projections is largely offsetby reduced world import prices and lower im-

7. Uncertainties


porter margins. These factors have led us torevise up projected inflation for 2000/01 onlyslightly. However, a further fall in the exchangerate that is not offset by either lower world pric-es or import-price margins would lead to highertradeables inflation. Of course, whether theincrease in inflation were to become more gen-eral, and hence become a policy concern, woulddepend on whether the increase in import pric-es were to flow through to prices fordomestically produced goods and services.

Prospects for import-price margins are a sig-nificant source of risk. In the last 12 months,reductions in importers’ (or overseas exporters’)profit margins have offset some of the exchangerate depreciation. These projections assumethat margins are stable over the medium term,with prices reflecting a slow appreciation of theexchange rate from early 1999. However, thesemargins may again increase significantly as theeconomy expands during 1999-2000, adding todomestic price pressures.

Domestic liquidity and confidenceFinally, the pick-up in economic growth couldbe both quicker and stronger than projected dueto the influence of expansionary monetary andfiscal policy and other positive factors. Theoverall expansion of fiscal policy, and the li-quidity effects from the share listing of AMP(and potential developments regarding TowerCorporation and the Public Trust Office), com-bine to provide a boost to household liquidity.Moreover, the easing in monetary conditionshas been substantial, falling from 1000 on theMCI in the December quarter of 1996 to a pro-jected trough of around 200 in late 1999(equivalent to a fall in nominal interest rates of8 percentage points), which will act to boosteconomic activity.


Listed below are recent events of relevance to monetary policy and inflation.

199715 December: A new Policy Targets Agreement (PTA) was signed by Treasurer Winston

Peters and Reserve Bank Governor Don Brash. The PTA is reproduced inAppendix 3.

16 December: The Reserve Bank released its seventeenth Monetary Policy Statement.The news release accompanying the Statement is reproduced in Appendix2.

199820 January: The December 1997 quarter CPI was released. The CPIX rose 0.5 percent

in the quarter and by 1.6 percent over the year to December.

23 February: The Reserve Bank issued a statement on current monetary conditions. Thestatement is reproduced in Appendix 2.

18 March: The Reserve Bank released its March 1998 Economic Projections. Theaccompanying news release is reproduced in Appendix 2.

27 March: The Reserve Bank issued a news release related to monetary conditions.The statement is reproduced in Appendix 2.

30 March: GDP production figures were released showing that the New Zealandeconomy grew 0.5 percent in the December quarter and by 2.3 percent inthe year to December 1997.

The Reserve Bank issued a statement on current monetary conditions. Thestatement is reproduced in Appendix 2.

17 April: The March 1998 quarter CPI was released. The CPIX rose 0.3 percent inthe March quarter and by 1.7 percent in the year to March 1998.

Appendix 1: Chronology


The following are reports or texts of official statements on monetary policy issues made by theBank during the period under review in this Monetary Policy Statement.

New “more transparent” Policy Targets Agreement15 December 1997

Treasurer Winston Peters and Reserve Bank Governor Don Brash this afternoon signed a new and“more transparent” Policy Targets Agreement (PTA). The PTA is required by the Reserve Bank ofNew Zealand Act 1989 and details the Reserve Bank’s inflation target.

Dr Brash commented: “All of the essential features of the previous PTA have been preserved, andin particular the commitment to keep consumer price inflation between 0 and 3 percent.

“The most significant change in the new PTA is that it now defines the Reserve Bank’s target interms of 12-monthly increases in the All Groups Consumers Price Index excluding Credit Services(CPIX), as published by Statistics New Zealand. The previous PTA defined the target in terms ofthe All Groups Consumers Price Index including interest rates and the price of other credit servic-es. This change is consistent with the recently-announced decision of Statistics New Zealand toexclude interest rates from the official CPI from 1999. The new PTA thus provides continuitybetween the current and future CPI measures.

“An important consequence of specifying the target measure in terms of the CPIX is that theprincipal difference between the CPI itself, the so-called headline measure of inflation, and theReserve Bank’s measure of underlying inflation will disappear, namely interest costs. For thisreason the Bank has decided to cease calculating and publishing its measure of underlying infla-tion with immediate effect. This helps to make the new arrangement even more transparent than inthe past.

“We have previously expressed some discomfort with being responsible for calculating underly-ing inflation, the benchmark against which our monetary policy performance is assessed. Althoughno serious observer has ever suggested that the Reserve Bank has ‘fiddled the number’, there hasbeen concern both inside and outside the Bank that it was the Bank which was making the calcu-lation.

“The decision to move to the CPIX as the basic measure of inflation in the new PTA, and therelated decision to cease publishing the underlying inflation measure, have no implications for theimplementation of monetary policy. Nor do the decisions have any implications for monitoringthe Reserve Bank’s performance. The Bank remains accountable for any actual, or projected,deviations from the official target range for inflation. The Bank must continue to explain anytemporary impacts on prices arising from events which may mask the underlying trend of inflationin the CPIX, which is the proper focus of monetary policy,” Dr Brash concluded.

Current conditions “appropriate”16 December 1997

The Reserve Bank today endorsed the recent market-led easing in monetary conditions.

That was announced with the release of the Reserve Bank’s December Monetary Policy Statementthis morning.

Appendix 2: Reserve Bank statements on monetary policy


Today’s move took the form of a 75 point drop in the desired level of the Reserve Bank’s MonetaryConditions Index (MCI) to 650, which is close to the current level of market conditions. This wasthe fourth easing by the Reserve Bank in the last 12 months.

Reserve Bank Governor Don Brash said “Today’s result reflects a mix of factors affecting infla-tionary pressures. During 1997 economic activity and inflation appear to have been a little strongerthan we expected. However, looking ahead, the impact of recent events in Asia is likely to moder-ate New Zealand’s economic growth and inflation. This will occur primarily through reducedexport prices and volumes, and reduced import prices.

“As a result, to maintain price stability, monetary conditions do not need to be as firm as weexpected back in September. The markets appear to have taken a similar view in recent weeks, somonetary conditions now are broadly appropriate. The Reserve Bank is not looking for any fur-ther easing in actual conditions at this time.

“The Reserve Bank expects growth rates in the economy to pick up over the next 12 to 18 months,supported by next year’s tax cuts, increased Government spending, increased business invest-ment, and this year’s easing in monetary conditions. That said, the situation in Asia continues tobe volatile and uncertain, which increases the degree of uncertainty in current inflation projec-tions,” Dr Brash concluded.

Notes for briefing journalists at the release of the December 1997Monetary Policy Statement16 December 1997

Introduction

Good morning and welcome to this briefing on the Reserve Bank’s December 1997 MonetaryPolicy Statement, the 17th we have issued.

As you will have seen already from reading that Statement, our view of the economy’s futuregrowth path has changed quite significantly since September. We now project that growth overthe March 1998 year as a whole will be around 2.5 percent (previously 1.7 percent), over the yearto March 1999 around 3 percent (previously 3.8 percent), and over the year to March 2000 around3.9 percent (previously 4.3 percent). This slower growth than previously projected in the years toMarch 1999 and 2000 is largely explained by our current assessment of the adverse impact of thedifficulties which several of our Asian trading partners are experiencing.

But the essential profile of the economy’s growth has not been materially changed: growth inoutput increases through 1998 and into 1999, before slowing to about its sustainable growth ratethrough late 1999 and early 2000.

Implications for inflation and monetary conditions

Unfortunately, and despite the economy operating a little below our estimate of its sustainablecapacity through much of 1997, inflation in sectors removed from international competition, so-called non-tradeables inflation, has remained remarkably persistent. This has been largely, but notexclusively, a result of continuing price pressures in the housing market and in some parts of the


public sector. As a result, and with the disinflationary benefit of a rising exchange rate now behindus, aggregate inflation is projected to be a little higher than previously over the next year or so.

Beyond the immediate future, several conflicting pressures are at work. Working to reduce infla-tion is the recent period of slower growth. This has created a situation of excess capacity in theeconomy in recent quarters, which is expected to persist throughout 1998 and assist in constrain-ing inflation for most of the projection period. Working in the same direction is the projectedweakness in some import and export prices as a result of the sharp downturn in activity in manyparts of Asia.

On the other side, working to push up domestic prices, is the sharp fall in the New Zealand dollarexchange rate over the last six months or so, although we expect that the effect of this may besomewhat muted by some reduction in the margins of importers and distributors built up duringthe period of exchange rate appreciation.

Taking all factors into account, and on the basis of the monetary conditions projected, we projectinflation moving back towards the middle of the target range, after a temporary increase.

Nominal monetary conditions are projected to remain around 650 on the MCI through 1998 andthe first half of 1999, before firming gradually beyond that.

Risks and uncertainties

As always, financial markets should not treat our projection of monetary conditions beyond thenext quarter as being set in stone. We, of course, provide a new assessment of desired conditionseach quarter, and at that time weigh all of the new information which has come to hand. Thatenables us to make an assessment of the monetary conditions which then seem appropriate tokeeping inflation moving towards the centre of our inflation target.

There are in fact two major uncertainties in the present situation, and those uncertainties point indiametrically opposite directions.

The first and most obvious risk is that the present difficulties in Asia turn out to be even moreserious than we have assumed. As the Statement indicates, we have already departed from ourusual practice of taking Consensus Forecasts for the six largest OECD countries as the basis forour assessment of the international environment: in particular, we have widened the group ofcountries factored into our view of the international environment to include 14 countries (includ-ing all our major Asian trading partners), and in addition have chosen a sub-set of the morepessimistic forecasters’ views.

But, by the nature of the case, any compilation of forecasts will be a little out-of-date in a fast-changing situation. As each day seems to suggest that the Asian situation is worse than envisagedeven a few days earlier, it is quite possible that we have still under-estimated the seriousness of theAsian situation. Between New Zealand’s direct exposure to Asia and our indirect exposure throughAustralia and Japan, there is no doubt that a very significant part of our total trade may be affectedby developments in Asia. Here, the risk seems to be that we may have under-estimated the disin-flationary pressures to which we may be subject in the next few years, and, if this turns out to bethe case, the inflation track may turn out to be lower than now projected. Putting the matter inanother way, monetary conditions may need to be easier than now projected to keep inflation inthe middle of the target range.


The second significant risk relates to the possibility that there will be a further change in the mix ofmonetary conditions in the direction of a lower exchange rate and higher interest rates than nowassumed, perhaps as a result of financial market concern at the continuing increase in New Zea-land’s current account deficit. There has already been a significant depreciation of the New Zealanddollar, both against the US dollar and on a trade-weighted basis, over the last six months, thoughinterestingly that depreciation has not been any greater since the beginning of the year than that ofthe Australian dollar, nor even much greater, against the US dollar, than that of major currenciessuch as the deutschemark or the yen. In other words, the ‘depreciation of the New Zealand dollar’to date is more accurately thought of as an ‘appreciation of the US dollar’. The New Zealanddollar certainly has not fallen in the way that many of the currencies in Asia have done.

But the current account deficit is projected to be significantly higher than we thought likely evenas recently as September. At that time, we expected the current account deficit to peak at about 5.8percent of GDP in the year to March 1998, trending down to 4.1 percent over the year to March2000. We now project the deficit to average around 7.7 percent over the year to March 1998(including the frigate imported this year) and, while trending down gradually, to still be at around6.4 percent of GDP over the year to March 2000.

This markedly higher deficit is a result in part of slightly smaller trade and migrant transfer sur-pluses over the next few years, in part the result of a slightly higher services deficit over thatperiod, but mainly the result of a significantly higher net deficit on investment income. That largernet deficit on investment income in turn is mainly the result not so much of higher profits earnedby foreign companies operating in New Zealand as of a markedly lower projected track for theprofits of New Zealand companies operating overseas, suggesting that New Zealand companieshave been rather less successful in their investments overseas in the recent past than have foreigncompanies investing in New Zealand.

Whatever the reasons, the larger current account deficit could prompt a further change in the mixof monetary conditions and, if this were to happen, a lower exchange rate would tend to pushprices up as compared with the track now projected. At the same time it is probably fair to notethat the higher interest rates which could also result from reduced confidence in the New Zealanddollar might well prompt some downward movement in the housing components of the CPI, thusproviding some offset to any exchange rate depreciation. If the exchange rate depreciation werelarge, however, it might still tend to push inflation above the track now projected, and requiremonetary conditions to be somewhat firmer than now projected.

Other issues

I want to cover a few other items.

First, despite some doubts which have been expressed about the way in which our MonetaryConditions Index is working, we are entirely happy with it. We are no more confident now thanwe were a year ago that we know with any degree of precision the comparative influence ofinterest rates and the exchange rate on medium-term inflation. Nor are we any more confidentabout the stability of that ratio over time. Clearly, our ‘two-for-one’ assumption is subject to veryconsiderable uncertainty. That is why, even in the immediate aftermath of a new projection, we donot force monetary conditions to conform exactly with ‘desired’. But the MCI reminds everybodythat, in a small open economy, both interest rates and the exchange rate form important parts of themonetary policy transmission mechanism, and gives markets some guide to how we weight therelative importance of those channels. It is especially useful in helping public understanding


when, as often in the last 12 months and more, interest rates and the exchange rate are moving inopposite directions. While few other central banks use such an index in a formal sense at this time,it is clear that all central banks, even the Federal Reserve Board in the US, have to take exchangerate effects on inflation into account in determining the appropriate stance of monetary policy.

Secondly, some observers have suggested recently that the Reserve Bank tends to ‘simply follow’where financial markets lead in terms of monetary conditions. It is certainly true that in recenttimes the market has tended to anticipate where the Bank wants monetary conditions to be so that,when each new quarterly projection is released, actual market conditions are often closely in linewith the conditions which the Bank indicates as ‘desired’. But as Dr Mervyn King, shortly to beDeputy Governor of the Bank of England, recently remarked, given a clear and publicly-knowninflation target, a broad consensus on how the economy works, and access to the same informationon the development of the economy, the central bank’s conclusions about the appropriate stance ofmonetary policy should not be a surprise to the markets. Indeed, what would be surprising is if thecentral bank and the markets were at substantial or frequent variance. Of course, there will betimes when the collective judgement of financial markets differs from that of the central bank, andon those occasions the central bank will need to make its own views known, as we ourselves dofrom time to time. But, as a rule, those occasions should be few and far between.

Thirdly, as we announced yesterday, a new Policy Targets Agreement has been signed by theTreasurer and me, and that defines the 0 to 3 percent target in terms of the CPI excluding creditservices, or CPIX. That does not involve any change in the way in which monetary policy isformulated or implemented but, because interest rates were by far the most frequent reason fordivergences between the official ‘headline’ rate of inflation and the Bank’s measure of underlyinginflation, moving to the CPIX has enabled the Bank to discontinue its underlying inflation series.Of course we will from time to time still need to give our best estimate of the impact of unusual ortemporary disturbances on the CPIX, and from time to time need to explain divergences from theagreed inflation target range, as envisaged in the Policy Targets Agreement. But using the newindex as the normal measure of the Bank’s inflation performance can only further enhance thetransparency of the monetary policy framework.

We are hopeful that, in 1999, we will be able to move to an index of consumption prices, involvingnot only the exclusion of interest rates from the measure of consumer price inflation but also thereplacement of certain asset prices (such as new house and section prices) by an alternative meas-ure of the price of actually using the services provided by those assets. The availability of thisindex, recently announced by the Government Statistician, will, we believe, be a marked advance.

Fourthly, a house-keeping matter. In the recent past, the timing of the release of our quarterlyprojections has seemed less than ideal in terms of the timing of the release by the GovernmentStatistician of important data on the CPI, GDP and other matters. In some cases over the last year,indeed, the Bank’s projections have been ‘dated’ within days of their release by data which hasbeen unexpectedly at variance with the assumptions on which the Bank based its projections. Forthis reason, we are intending to change the dates on which we release our projections in 1998. Wenow plan to release Economic Projections in mid-March (as previously); our next Monetary Pol-icy Statement in mid-May (some six weeks earlier than this year); our second Economic Projectionsfor the year in mid-August; and our second Monetary Policy Statement for the year in mid-No-vember.

Finally, let me respond to a criticism that I still hear occasionally, and that is that if only the Bankwere not so single-minded in its focus on keeping inflation low, New Zealand would be able to


grow at a faster average rate, would have higher employment, or even would have a smaller bal-ance of payments deficit. Getting sustainably higher economic growth, or more employment, or alower balance of payments deficit are all worthy objectives. Unfortunately, there is not the slight-est evidence, from New Zealand’s own experience or from the experience of other countries, thatthey can be achieved by tolerating more inflation. If anybody thinks that they have such evidence,I’d be very keen to see it. So far nobody has produced any.

Monetary conditions easing too far23 February 1998

David Archer, Chief Manager of the Reserve Bank’s Financial Markets Department, said todaythat actual monetary conditions have eased too far over recent days.

“We would not be comfortable with any further easing in actual conditions at this stage, and wouldprefer to see conditions settle a little closer to the announced desired level.”

Reserve Bank eases monetary policy again18 March 1998

The Reserve Bank today announced a further easing of monetary policy. This is the fifth easingsince late 1996, and came with the release of the Reserve Bank’s March 1998 Economic Projec-tions.

Today’s move took the form of a 150 point drop in the desired level of the Bank’s MonetaryConditions Index (MCI), to 500. This is a little lower than where actual monetary conditions havebeen in recent weeks.

Reserve Bank Governor Don Brash commented: “The economic outlook in Asia has deterioratedsignificantly since the Bank completed its last policy statement in December. Partly as a conse-quence, domestic consumer and business confidence have also fallen. These new developmentsmake it appropriate for the Bank to ease monetary policy now by more than we had previouslyexpected. Doing so should keep inflation near the centre of the target range, and should alsoreduce the risk of a sharp decline in economic activity.

“These effects are offset in part, but only in part, by the significant fall in the exchange rate inrecent months, which will add directly to inflation in the short term. Looking further ahead, as wemust do in setting monetary policy, Government tax cuts and the AMP demutualisation will alsoboost domestic spending. These conflicting forces each influence the way the Reserve Bank needsto run monetary policy to keep inflation within the 0 to 3 percent target range.”

Dr Brash added that today’s Projections came at a time of considerable uncertainty.

“These Projections suggest that further monetary policy easings are possible over the next year orso. But whether they take place will depend entirely on how the inflation outlook develops. Forthat, what happens in Asia and further abroad will matter a lot. But so too will events closer tohome, including the extent to which households continue to increase their borrowings, and thewillingness of international markets to continue to finance large current account deficits.”


Notes for briefing journalists at the release of the March 1998Economic Projections18 March 1998

Economic circumstances have changed since December

Good morning.

Since we finalised our most recent Monetary Policy Statement in early December, it is ourjudgement that economic circumstances have changed quite significantly.

To be sure, since December the domestic economy has evolved more or less in line with our earlierexpectations. In particular, inflation outcomes have been broadly in line with those we expected inDecember and we currently expect that output growth over the December 1997 and March 1998quarters will also have been in line with our earlier view. But there have been three significantchanges from what we had previously expected.

First, the exchange rate has fallen considerably more than projected.

Secondly, and perhaps most importantly, the outlook for world growth has been revised downsubstantially, largely because of developments related to the East Asian crisis. In these projec-tions, we have again adopted a pessimistic view about world growth prospects. Although there aresome positive signs emanating from East Asia – especially from Thailand and Korea – events inIndonesia are quite volatile, and Japan may be headed into outright recession. As a result, sinceDecember most observers have substantially lowered their estimates of growth in East Asia. Al-though prospects look solid for the US, Australia, and Europe, these prospects are not sufficient tooffset the negative implications for New Zealand of lower Asian growth. As a consequence, wenow believe that export growth will be substantially weaker than projected in December.

Thirdly, and no doubt in part related to the weaker international environment and media coverageof that, both consumer and business confidence have weakened significantly in recent months.This is likely to restrain domestic expenditure by more than we expected in early December. Inaddition, more subdued housing prices seem likely to alter households’ views of their wealth,providing a further dampening influence on spending.

Overall, weaker export growth and weaker domestic demand tend to reduce output growth in theyear to March 1999. This implies that aggregate supply will exceed aggregate demand by morethan we had thought likely in December, and for a rather longer time.

Implications for inflation and monetary conditions

The implication of these changes – a lower exchange rate and weaker domestic and external de-mand than we had projected in December – is a slightly higher inflation track in the next two yearsbut appreciably lower domestic inflationary pressures over most of the period covered by theseprojections.

As a result, we have lowered our assessment of desired monetary conditions for the June quarterfrom the 650 we projected in the December Monetary Policy Statement to 500, with a furthereasing in monetary conditions conditionally projected through the beginning of the year 2000. (Iwill come back to what I mean by ‘conditionally’ in a moment.)


Why, it might be asked, are we projecting such an easing given that the inflation track will beslightly higher than we projected in December? The reason is that, at this point, tighter monetaryconditions would do little to prevent the near-term rise in inflation that we are projecting. Instead,taking a forward-looking approach, a loosening of monetary conditions now is warranted to offsetthe expected disinflationary consequences of the weaker profile for demand. Thus, today’s eas-ing, and the conditional easings projected for coming quarters, should serve to keep the inflationrate near the mid-point of the 0 to 3 per cent target range in the years to March 2000 and 2001.

Implications for the real economy

If things evolve in the way we now project, growth in GDP in the year to March 1999 (annualaverage) will be 2.8 percent, that in the year to March 2000 will be 4.2 percent, and that in the yearto March 2001 will be 2.7 percent. This means that we are now projecting slightly lower growthin the year to March 1999 than we were in December (2.8 percent instead of 3.0 percent) butslightly stronger growth in the year to March 2000 (4.2 percent instead of 3.9 percent). Over thetwo years starting 1 April this year, therefore, the difference is negligible. (We did not previouslyproject a GDP growth figure for the year to March 2001.)

Again if things evolve in the way we now project, we see government’s operating balance as ashare of GDP being slightly stronger than we did in December, with the balance of paymentscurrent account deficit being fractionally higher in the years to March 1998 and March 1999 butrather lower than previously projected in the following years.

At first sight it may appear that there is an inconsistency between the significant monetary policyeasing envisaged in these Projections on the one hand and the slightly higher inflation outcomesand relatively robust economic growth on the other. But in fact there is no inconsistency.

In the absence of the monetary policy easing projected, economic growth would be considerablyweaker than now projected for the years 2000 and 2001, and as a consequence inflation would beheading well below the middle part of the 0 to 3 percent inflation target. In fact, what we see inthis situation is an illustration of how monetary policy exclusively focused on delivering pricestability has the important ancillary benefit of smoothing business cycles also. While this inevita-bly means that we lean against a rapid expansion of demand when it looks likely that this willincrease inflation, we also ease policy when this can be done without rekindling inflation, and thisis particularly true if it looks as if inflation will head below the bottom of the 0 to 3 percentinflation target we have been set by Government.

Risks and uncertainties

You will have seen that, as usual, we have devoted a section of the document to a discussion of therisks and uncertainties in the projection. There are two risks which need to be particularly noted.

First, although the exchange rate has depreciated since the December Monetary Policy Statement,and that should ultimately help to improve our external position, the current account deficit is stillexpected to remain quite high over the projection period. While these Projections represent ourbest judgement about the likely course of the economy, financial market participants might take adifferent view. In particular, if concerns about the current account deficit increased, the currencymight prove to be weaker than we are expecting. If so, interest rates would need to be higher than


we are now projecting to stem the inflationary consequences. As we note in the Projections, undersome circumstances overall monetary conditions might need to remain tighter than now envis-aged.

Secondly, it is possible that the outlook for demand could turn out to be different than we envisage.In this regard, a principal risk is the Asian crisis. The affected economies will begin to recover atsome point, but when that will occur is still quite unclear. On the other hand, it is possible thatgrowth in Europe and the US could provide a bigger offset to weak Asian demand than nowexpected.

The Bank will be watching these developments closely. And in that connection I need to stressthat the track of future monetary conditions now projected is highly conditional. That has alwaysbeen true, but it is particularly important to stress the point in a situation where the projected trackshows quite a marked further change in monetary conditions. Because of the uncertainty in-volved, financial markets should understand that the Bank will resist vigorously any tendency toanticipate the easing now projected for the period beyond the June 1998 quarter.

We will not, of course, expect monetary conditions to be right on 500 on the Monetary ConditionsIndex at all times, any more than we have insisted on such a close correspondence between actualand desired monetary conditions in the past.

As I have indicated previously, our tolerance of deviations from the Bank’s desired conditions willdepend on the circumstances in which the deviation occurs. For example, we may be more willingto accept deviations which occur due to sharp adjustments in overseas exchange rates, where localinterest rates and exchange rates take time to adjust. We are likely to be less complacent if mone-tary conditions change rapidly, and appear to be building some momentum, without any obviousdevelopments which suggest that the future inflation track will be markedly different from thatpreviously projected.

As a very approximate guide, we would expect actual monetary conditions to be within a range ofplus or minus 50 MCI points from desired in the period immediately following a comprehensiveinflation projection. As data comes to hand which may alter the inflation projection, and as ourlast comprehensive inflation projection recedes into history, we may well be more comfortablewith a greater divergence between actual conditions and that now announced as desired.

Having said that, it is important to remember that we periodically reset the desired level of mone-tary conditions taking into account all new information, as well as changes in our views aboutwhat that information means for future inflation. Only in quite exceptional circumstances wouldwe formally reset ‘desired’ monetary conditions other than in the context of that comprehensivequarterly review, but we may well, as indicated, become more tolerant of deviations of actualconditions from desired as new information suggests that that is warranted.

Criticisms of the Monetary Conditions Index

There have been two criticisms of the Monetary Conditions Index in recent months to which Iwould like to respond.

The first is that, because the Bank’s measure of the New Zealand dollar exchange rate, the TWI,includes no Asian currencies except the Japanese yen, the exchange rate component of the MCI


significantly overstates the recent fall in the New Zealand dollar and therefore overstates the ex-tent to which monetary conditions have eased in recent months. It is certainly true that the Bank’sTWI does not include any of the currencies against which the New Zealand dollar has appreciatedvery sharply recently, but it does not follow that the TWI seriously overstates the extent to whichthe New Zealand dollar’s recent depreciation affects New Zealand inflation, which is, of course,our only concern. Box 3, which starts on page 23, tries to deal with that issue. The key point is thatwe still believe that the TWI is a reasonable approximation of the extent to which movements inthe New Zealand dollar affect our inflation rate.

Moreover, even if the fall in the TWI slightly overstates the impact which recent exchange ratemovements are likely to have on our inflation rate, it is quite likely that there is an offsettingoverstatement arising from the way in which interest rates are measured in the MCI. At the presenttime, we factor in the influence of interest rates on the inflation rate by including the 90 dayinterest rate in our MCI. But in the last year or two there has been a very strong increase in banklending which is priced not off the 90 day interest rate but off interest rates further down the yieldcurve. Partly because of recent very strong capital inflow in the form of Eurokiwi bond issues,these longer-term interest rates have tended to be significantly lower than 90 day interest rates.What is relevant for my argument is that, in recent months, the 90 day interest rate has increasedquite strongly and that has been incorporated into the calculation of our MCI. Had we been usinga longer-term interest rate – perhaps a one year or three year interest rate, for example – the effectwould have been to show a significantly greater easing in monetary conditions than that shown bythe MCI as presently constructed.

Of course, this simply illustrates something which we have always recognised: the MCI is notperfect. It does not take account of a host of relevant financial market prices, including longer-term interest rates, share market prices, and forward exchange rates. But then we have neversuggested for a moment that it is perfect, and I suspect that we will continue to fine-tune it in theyears ahead. Criticism from market commentators will be helpful in that regard. One of thereasons for allowing actual monetary conditions to diverge from ‘desired’ is precisely this uncer-tainty about the precise weights to be given to different components of monetary conditions. Butthe MCI has the important benefit that it forces financial markets and the Reserve Bank to considerthe impact of both interest rates and the exchange rate when assessing the influence of monetarypolicy on inflation, and we have no intention of abandoning it. When we prepare our quarterlyinflation projections, we do not use the MCI as such, but rather look at each of the various factorswhich have a bearing on inflation over the policy-relevant period. The MCI is useful thereforeprimarily as a guide to financial markets between these quarterly projections; comparing the abso-lute level of monetary conditions as measured by the MCI over a long period of time has littlemeaning.

The second criticism of the MCI tends to come not so much from New Zealand financial marketcommentators as from the local business community and from overseas funds managers. How, itis sometimes asked, can you claim that monetary policy is easing when 90 day interest rates arehigh or rising? Or more simply, given reduced inflationary pressures, why isn’t the Reserve Bankeasing monetary policy?

My response to that criticism is that the Bank has been sanctioning a gradual easing of monetarypolicy for more than a year. One can debate, of course, whether we should have been easing moreaggressively, though there is little evidence in the inflation outcomes so far that a more aggressiveeasing would have been warranted. But overall monetary conditions have been steadily easing,with a substantial fall in the exchange rate (some 10 percent from its peak on a TWI basis, some 18


percent against the US dollar) offset by some increase in short-term interest rates. The fall in theexchange rate will, in our judgement, provide more stimulus to the economy, and thus more up-wards pressure on inflation, than the rise in short-term interest rates will dampen demand andinflationary pressures. In other words, in our judgement the overall impact of monetary policyover the last year has been to stimulate aggregate demand and thus to offset the disinflationaryforces which are outlined in the Projections.

Given the slowing but still-strong domestic demand for credit, and the size of the balance ofpayments deficit, it is neither a source of surprise nor dismay that recent easing in monetary con-ditions has taken the form of a lower exchange rate and higher interest rates. No doubt as thedemand for credit slows further, and the balance of payments deficit shrinks, the mix of monetaryconditions will change again.

The last issue of Economic Projections

I mentioned in December that we were proposing to modify the timetable for issuing MonetaryPolicy Statements and Economic Projections from 1998, with our next Monetary Policy Statementpublished in mid-May (instead of late June, as in recent years), our next Economic Projectionspublished in mid-August (instead of in September), and our final Monetary Policy Statement forthe year published in mid-November (instead of in December). This change was essentially relat-ed to the timing of some key data releases by the Government Statistician.

We have now decided to discontinue publishing a document entitled Economic Projections. Inother words, this March 1998 edition will be the last.

Instead, we propose to call all major published analyses of the inflation outlook Monetary PolicyStatements. The Reserve Bank Act requires us to publish such Statements at least every six months,and in fact we will usually issue them at approximately quarterly intervals. It may be that therewill be some variation in the content of the Statements from time to time, with some devotingmore emphasis to some issues than others, but there will be no significant change in the frequencywith which we comment on the inflation outlook.

We are making this change partly to reduce public and media confusion (until now we have effec-tively published inflation projections each quarter but only issued Monetary Policy Statementssix-monthly) and partly to reflect the fact that the two documents have evolved over time to thepoint where they are, from the point of view of financial markets, of equal importance as state-ments of the Bank’s view.

Markets over-react to policy easing27 March 1998

Reserve Bank Governor, Don Brash, today responded to financial markets’ increasing over-reac-tion to the policy easing announced by the Bank last week.

“Last week we eased monetary policy significantly. Monetary conditions adjusted fully to thatmove, and indeed have increasingly anticipated further policy easings to too great an extent.

“We have been waiting to see whether the easing in monetary conditions would moderate of its


own accord, and have been conscious that new data is due today and Monday. That moderationhas not happened. We will of course be watching carefully what implications the emerging datawill have for the inflation outlook. We may need to adjust the cash target”, Dr Brash warned.

“I am aware that many people will be puzzled by the idea that monetary conditions have eased toomuch when interest rates have risen. However, the exchange rate has fallen substantially. Mone-tary conditions are a combination of interest rates and the exchange rate, and the combination ofthe two has gone too far at this time”, Dr Brash said.

Confusion over interpretation of recent Economic Projections30 March 1998

The significance of parts of the Reserve Bank’s 18 March Economic Projections have been misin-terpreted by some, the Reserve Bank said today.

That’s come in a speech to a Stratford business audience by Reserve Bank Monetary Policy Imple-mentation Manager Michael Reddell.

Mr Reddell said: “An impression seems to have formed that, when the Reserve Bank eased mon-etary policy on 18 March, we also specifically set out to push the exchange rate down and interestrates up. That is not correct.

“Both interest rates and the exchange rate influence inflation. Monetary policy can alter these twoin combination, but whether one goes up and the other goes down, or vice versa, is beyond thecontrol of the Reserve Bank. Rather, it is the result of trading in the financial markets, reflectingdecisions taken by many thousands of people, both here and abroad.

“Following our latest easing (18 March), demand for New Zealand currency fell. This was be-cause investors here and abroad concluded that this and possible future monetary policy easingsmean the exchange rate will fall further, and that to avoid additional losses they should sell now.That is simply supply and demand at work.

“In response to the exchange rate falling, markets have also pushed up interest rates. If interestrates had not gone up, the exchange rate fall would have taken overall monetary conditions wellbelow the level currently required by the Reserve Bank to maintain price stability over the medi-um term. Overall monetary conditions have, of course, still eased substantially since the release ofthe Economic Projections.”

Mr Reddell then said that there had also been some misunderstanding about the status of theReserve Bank’s projections for interest rates and the exchange rate.

“Our projections for interest rates and the exchange rate are one scenario, based loosely on theway we think the economy and markets work. But that’s all they are. They don’t decide eventsand are not an instruction or even guidance to the markets. The Reserve Bank sets a target level foroverall monetary conditions, but that’s all. The fact that we built into the projections some furtherexchange rate falls and, in the short term, further interest rate rises, rather than the other wayaround, simply reflected our sense of what might happen, as opposed to anything we specificallyset out to achieve.”


Mr Reddell added that the impression that somehow the Reserve Bank had recently changed itsapproach to monetary policy was also wrong.

“The Reserve Bank is not putting less emphasis on price stability than previously – we have notgone soft on inflation. Nor have we changed the way we present our – highly conditional – futurepath for monetary conditions in the Bank’s quarterly policy statements. As in the past, our indica-tions of where monetary conditions may go in the future are our best judgement, based on theinformation available when the Projections were done. The forward track in our projections haschanged, because the world has changed. In other words, the economic outlook has changed, butour approach to it has not,” Mr Reddell concluded.


This agreement between the Treasurer and the Governor of the Reserve Bank of New Zealand (theBank) is made under sections 9(1) and 9(4) of the Reserve Bank of New Zealand Act 1989 (theAct), and shall apply for the balance of the Governor’s present term and for his next five year term,expiring on 31 August 2003. It replaces that signed on 10 December 1996.

In terms of section 9 of the Act, the Treasurer and the Governor agree as follows:

1. Price stability

Consistent with section 8 of the Act and with the provisions of this agreement, the Bank shallformulate and implement monetary policy with the intention of maintaining a stable general levelof prices, so that monetary policy can make its maximum contribution to sustainable economicgrowth, employment and development opportunities within the New Zealand economy.

2. Policy target

a) In pursuing the objective of a stable general level of prices, the Bank shall monitor prices asmeasured by a range of price indices. The price stability target will be defined in terms ofthe All Groups Consumers Price Index excluding Credit Services (CPIX), as published byStatistics New Zealand.

b) For the purpose of this agreement, the policy target shall be 12-monthly increases in theCPIX of between 0 and 3 percent.

c) Notwithstanding clause 2(a), the Treasurer and the Governor may agree to use an alterna-tive index of consumer price inflation following the implementation of the changes to thecalculation of consumer prices proposed by the Government Statistician to take effect dur-ing 1999.

3. Unusual events

a) There is a range of events that can have a significant temporary impact on inflation asmeasured by the CPIX, and mask the underlying trend in prices which is the proper focus ofmonetary policy. These events may even lead to inflation outcomes outside the target range.Such disturbances include, for example, shifts in the aggregate price level as a result ofexceptional movements in the prices of commodities traded in world markets, changes inindirect taxes, significant government policy changes that directly affect prices, or a naturaldisaster affecting a major part of the economy.

b) When disturbances of the kind described in clause 3(a) arise, the Bank shall react in amanner which prevents general inflationary pressures emerging.

Appendix 3: Policy Targets Agreement


4. Implementation and accountability

a) The Bank shall constantly and diligently strive to meet the policy target established by thisagreement.

b) It is acknowledged that, on occasions, there will be inflation outcomes outside the targetrange. On those occasions, or when such occasions are projected, the Bank shall explain inPolicy Statements made under section 15 of the Act why such outcomes have occurred, orare projected to occur, and what measures it has taken, or proposes to take, to ensure thatinflation comes back within that range.

c) The Bank shall implement monetary policy in a sustainable, consistent and transparentmanner.

d) The Bank shall be fully accountable for its judgements and actions in implementing mone-tary policy.


Tabl

e A

CP

I inf

latio

n pr

ojec

tions

and

mon

etar

y co

nditi

ons

(CP

IX a

nd

CP

I a

re p

erc

en

tag

e c

ha

ng

es)

CP

IXC

PI

TW

I90

-day

rat

eM

CI

Qua

rter

lyA

nnua

lQ

uart

erly

Ann

ual

Nom

inal

Rea

l

19

95

Ma

r.0

.52

.61

.24

.05

9.8

9.4

47

44

14

Jun

.0

.62

.71

.04

.66

0.8

9.1

52

74

58

Se

p.

0.4

2.2

0.2

3.5

61

.79

.05

90

57

9D

ec.

0.6

2.1

0.6

2.9

61

.98

.55

57

57

81

99

6M

ar.

0.6

2.1

0.5

2.2

64

.28

.77

59

76

5Ju

n.

0.8

2.3

0.8

2.0

64

.69

.78

90

88

6S

ep

.0

.42

.30

.62

.46

5.6

10

.09

97

10

04

De

c.0

.72

.40

.72

.66

7.1

8.9

10

00

10

00

19

97

Ma

r.0

.22

.0-0

.31

.86

8.4

7.5

95

69

79

Jun

.0

.31

.50

.11

.16

8.0

7.2

89

79

55

Se

p.

0.7

1.8

0.5

1.0

64

.88

.17

46

80

2D

ec.

0.5

1.6

0.6

0.8

63

.97

.96

56

75

01

99

8M

ar.

0.3

1.7

0.2

1.3

61

.28

.95

50

66

9Ju

n.

0.2

1.6

0.3

1.5

59

.09

.13

75

52

5S

ep

.0

.41

.30

.31

.35

8.7

9.1

35

05

50

De

c.0

.41

.20

.41

.15

8.4

8.5

27

54

75

19

99

Ma

r.0

.51

.40

.21

.15

8.5

8.0

22

54

25

Jun

.0

.51

.60

.10

.95

8.7

7.6

20

03

75

Se

p.

0.5

1.7

0.2

0.8

58

.97

.32

00

32

5D

ec.

0.4

1.8

0.3

0.7

59

.47

.02

00

30

02

00

0M

ar.

0.4

1.8

0.3

0.8

59

.86

.82

25

30

0Ju

n.

0.4

1.7

0.3

1.0

60

.26

.72

25

32

5S

ep

.0

.41

.70

.41

.36

0.8

6.8

30

03

50

De

c.0

.41

.60

.51

.56

1.3

7.1

37

54

00

20

01

Ma

r.0

.41

.50

.61

.96

1.8

7.5

45

04

75

App

endi

x 4:

Sum

mar

y ta

bles


Tabl

e B

Wor

ld o

utlo

ok(A

nn

ua

l ave

rag

e p

erc

en

tag

e c

ha

ng

e)

Act

uals

Pro

ject

ions

Mar

ch y

ear

1992

1993

1994

1995

1996

1997

1998

e19

9920

0020

01

Ind

ust

ria

l pro

du

ctio

n-0

.9-0

.9-0

.45

.52

.52

.53

.71

.33

.42

.8

Wo

rld

CP

I in

flatio

n3

.22

.71

.92

.22

.52

.62

.61

.72

.12

.3

Do

me

stic

Imp

ort

pri

ces

1.0

6.7

-2.7

-1.8

-0.7

-3.4

1.6

5.2

-1.5

-1.6

Exp

ort

pri

ces

-1.3

9.3

-1.2

-2.1

-2.8

-4.2

0.2

7.0

1.4

-1.3

Term

s o

f tr

ad

e-2

.32

.41

.5-0

.3-2

.2-0

.9-1

.41

.72

.90

.3

Mar

ch q

uart

er

Wo

rld

90

-da

y ra

te4

.73

.63

.76

.55

.75

.55

.55

.85

.85

.7W

orl

d b

on

d r

ate

7.8

6.7

6.2

8.0

6.4

6.8

5.6

6.3

6.4

6.2

e =

est

ima

te


Tabl

e C

Com

posi

tion

of r

eal G

DP

gro

wth

(An

nu

al a

vera

ge

pe

rce

nta

ge

ch

an

ge

, u

nle

ss s

pe

cifie

d o

the

rwis

e)

Act

uals

Pro

ject

ions

Mar

ch y

ear

1992

1993

1994

1995

1996

1997

1998

e19

9920

0020

01

Fin

al c

on

sum

ptio

n e

xpe

nd

iture

Pri

vate

-2.0

0.3

3.2

6.1

4.1

4.1

3.4

2.1

2.5

2.7

Pu

blic

au

tho

rity

0.0

3.0

-1.1

-0.9

2.8

2.2

6.1

1.7

-0.6

3.1

Tota

l-1

.60

.92

.34

.63

.93

.73

.92

.01

.92

.8

Gro

ss f

ixe

d c

ap

ital f

orm

atio

nM

ark

et

sect

or:

Re

sid

en

tial

-15

.32

.81

7.1

12

.2-0

.72

.07

.1-8

.32

.83

.5B

usi

ne

ss-2

0.7

5.3

20

.31

6.1

14

.14

.9-3

.14

.79

.79

.8N

on

-ma

rke

t g

ove

rnm

en

t se

cto

r-3

.5-3

.18

.43

6.9

3.2

24

.42

1.2

2.2

0.5

3.7

Tota

l-1

7.6

3.7

18

.21

7.2

9.3

6.4

2.2

1.5

6.9

7.7

Fin

al d

om

est

ic e

xpe

nd

iture

-4.6

1.3

5.0

7.0

5.0

4.3

3.5

1.9

3.0

3.9

Sto

ckb

uild

ing(1

)0

.00

.71

.10

.0-0

.7-0

.40

.4-0

.20

.40

.0G

ross

nat

iona

l exp

endi

ture

-4.6

2.0

6.1

6.9

4.2

3.9

3.8

1.7

3.3

3.8

Exp

ort

s o

f g

oo

ds

an

d s

erv

ice

s9

.32

.57

.98

.42

.63

.82

.00

.75

.94

.5Im

po

rts

of

go

od

s a

nd

se

rvic

es

-3.8

7.4

8.0

14

.37

.36

.94

.30

.33

.75

.4E

xpen

ditu

re o

n G

DP

-1.1

0.8

6.1

5.3

2.7

2.9

3.1

1.9

4.0

3.5

GD

P (

prod

uctio

n)-1

.21

.26

.25

.43

.62

.72

.52

.24

.03

.5G

DP

(p

rod

uct

ion

, M

arc

h q

tr t

o M

arc

h q

tr)

0.7

2.0

6.8

4.7

3.3

1.6

2.7

3.0

4.3

2.9

Po

ten

tial o

utp

ut

0.4

1.4

2.8

3.6

3.9

3.8

3.7

3.5

2.6

2.4

Ou

tpu

t g

ap

(ye

ar

ave

rag

e)

-2.6

-2.9

0.4

2.1

1.8

0.8

-0.4

-1.7

-0.3

0.7

e =

est

ima

te(1

) P

erc

en

tag

e p

oin

t co

ntr

ibu

tion

to

th

e g

row

th r

ate

of

GD

P.


Tabl

e D

Hou

seho

ld in

com

e an

d co

nsum

ptio

n(A

nnua

l ave

rage

per

cent

age

chan

ge)

Act

uals

Pro

ject

ions

Mar

ch y

ear

1992

1993

1994

1995

1996

1997

1998

e19

9920

0020

01

Co

mp

en

satio

n o

f e

mp

loye

es

-1.1

2.4

4.4

6.4

6.6

5.5

2.7

2.7

5.2

5.2

Oth

er

inco

me

0.2

-2.5

4.7

4.9

9.4

5.8

4.2

8.0

1.7

2.7

Tota

l in

com

e-0

.5-0

.14

.55

.68

.05

.63

.55

.43

.43

.9

No

min

al d

isp

osa

ble

inco

me

2.4

-0.4

5.0

5.0

6.9

5.4

4.1

5.6

4.4

4.2

Co

nsu

mp

tion

de

flato

r2

.21

.71

.71

.92

.51

.71

.11

.31

.81

.6R

ea

l dis

po

sab

le in

com

e0

.2-2

.03

.23

.04

.33

.63

.04

.22

.62

.5

Re

al h

ou

seh

old

co

nsu

mp

tion

-2.2

0.3

3.1

6.1

3.9

4.0

3.4

1.9

2.4

2.6

Ho

use

ho

ld s

avi

ng

s ra

te(1)

6.5

4.3

4.4

1.5

1.8

1.4

1.0

3.2

3.5

3.4

e =

est

ima

te(1

) P

erc

en

tag

e o

f d

isp

osa

ble

inco

me

.


Tabl

e E

Fis

cal a

ccou

nts

($ b

illio

n)

Act

uals

Pro

ject

ions

June

yea

r19

9319

9419

9519

9619

9719

98e

1999

2000

2001

Re

ven

ue

Dir

ect

ta

xatio

n1

6.6

17

.61

9.8

21

.32

0.5

21

.72

1.6

22

.82

3.9

Ind

ire

ct t

axa

tion

9.2

10

.11

0.4

11.0

11.4

11.9

12

.11

2.4

12

.8N

on

-ta

x re

ven

ue

4.0

2.5

3.4

2.8

2.9

2.5

2.6

2.7

2.8

Tota

l re

ven

ue

29

.83

0.2

33

.63

5.1

34

.83

6.0

36

.43

7.8

39

.5

Tota

l exp

en

ses

31

.42

9.6

30

.43

1.7

33

.03

4.4

35

.83

6.9

37

.9

Re

ven

ue

less

exp

en

ses

-1.6

0.5

3.2

3.3

1.8

1.7

0.5

1.0

1.6

Ne

t su

rplu

s a

ttri

bu

tab

le t

o S

OE

s a

nd

Cro

wn

en

titie

s0

.80

.2-0

.60

.00

.11

.10

.91

.01

.1

Op

era

ting

ba

lan

ce-0

.80

.82

.73

.31

.92

.81

.52

.02

.7(%

of

no

min

al e

xpe

nd

iture

GD

P)

-1.1

0.9

3.1

3.6

2.0

2.7

1.4

1.7

2.3

Ne

t p

ub

lic d

eb

t3

7.1

35

.43

2.6

28

.62

5.3

24

.32

4.3

23

.42

2.3

(% o

f n

om

ina

l exp

en

ditu

re G

DP

)4

8.7

43

.13

7.1

31

.12

6.3

24

.12

2.8

20

.91

9.1

e =

est

ima

te


Tabl

e F

Inve

stm

ent

(An

nu

al a

vera

ge

pe

rce

nta

ge

ch

an

ge

)

Act

uals

Pro

ject

ions

Mar

ch y

ear

1992

1993

1994

1995

1996

1997

1998

e19

9920

0020

01

Pla

nt

an

d m

ach

ine

ry-2

2.9

15

.62

5.8

19

.41

2.7

3.8

3.3

7.4

11.6

9.8

(exc

lud

ing

co

mp

ute

rs)

-24

.61

4.5

25

.01

3.7

7.6

-1.4

-4.3

4.0

11.2

9.8

Tra

nsp

ort

eq

uip

me

nt

-20

.92

5.4

21

.011

.06

.81

2.4

-23

.44

.35

.48

.6C

om

me

rcia

l bu

ildin

gs

-38

.42

.12

6.1

26

.92

2.8

-0.4

-6.7

-3.7

14

.91

4.4

Oth

er

9.5

-30

.7-7

.4-7

.72

2.0

7.8

4.7

4.1

-3.4

3.4

Ma

rke

t se

cto

r b

usi

ne

ss in

vest

me

nt

-20

.75

.32

0.3

16

.11

4.1

4.9

-3.1

4.7

9.7

9.8

(exc

lud

ing

co

mp

ute

rs)

-21

.44

.31

9.6

12

.911

.72

.4-7

.82

.59

.19

.8

Ma

rke

t se

cto

r re

sid

en

tial i

nve

stm

en

t-1

5.3

2.8

17

.11

2.2

-0.7

2.0

7.1

-8.3

2.8

3.5

Tota

l ma

rke

t se

cto

r in

vest

me

nt

-19

.24

.61

9.4

15

.01

0.1

4.2

-0.7

1.4

8.1

8.4

Go

vern

me

nt

(no

n-m

ark

et)

inve

stm

en

t-3

.5-3

.18

.43

6.9

3.2

24

.42

1.2

2.2

0.5

3.7

Tota

l inv

estm

ent

-17

.63

.71

8.2

17

.29

.36

.42

.21

.56

.97

.7(e

xclu

din

g c

om

pu

ters

)-1

8.1

3.0

17

.51

5.0

7.2

4.3

-1.3

-0.6

5.9

7.3

e =

est

ima

te


Tabl

e G

Trad

e vo

lum

es a

nd th

e cu

rren

t acc

ount

Act

uals

Pro

ject

ions

Mar

ch y

ear

1992

1993

1994

1995

1996

1997

1998

e19

9920

0020

01

Trad

e vo

lum

es(A

nn

ua

l ave

rag

e p

erc

en

tag

e c

ha

ng

e)

Exp

ort

s o

f g

oo

ds

10

.30

.66

.97

.20

.86

.94

.80

.65

.24

.3E

xpo

rts

of

serv

ice

s5

.99

.511

.31

2.5

8.1

-4.9

-7.2

1.2

8.5

5.3

Tota

l exp

orts

9.3

2.5

7.9

8.4

2.6

3.8

2.0

0.7

5.9

4.5

Imp

ort

s o

f g

oo

ds

-5.7

8.1

12

.11

5.6

7.0

7.3

4.6

-0.2

4.0

5.7

Imp

ort

s o

f se

rvic

es

3.0

5.1

-5.3

9.1

8.2

5.0

3.2

2.4

2.6

4.0

Tota

l im

port

s-3

.87

.48

.01

4.3

7.3

6.9

4.3

0.3

3.7

5.4

Cur

rent

acc

ount

($ b

illio

n M

arc

h y

ea

r a

nn

ua

l to

tal)

Me

rch

an

dis

e t

rad

e b

ala

nce

3.6

3.4

3.1

2.1

0.9

0.9

0.8

1.9

3.2

3.1

Se

rvic

es

ba

lan

ce-1

.4-1

.7-0

.9-0

.6-0

.2-0

.6-1

.5-2

.5-2

.1-1

.9In

vest

me

nt

inco

me

ba

lan

ce-4

.8-3

.9-4

.5-6

.0-6

.0-7

.1-8

.2-8

.2-8

.3-8

.6T

ran

sfe

rs b

ala

nce

0.7

0.9

1.5

1.8

2.5

2.3

0.6

0.5

0.8

0.9

Cur

rent

acc

ount

-1.9

-1.3

-0.8

-2.6

-2.8

-4.5

-8.2

-8.3

-6.5

-6.5

(% o

f n

om

ina

l pro

du

ctio

n G

DP

)-2

.6-1

.7-1

.0-3

.1-3

.1-4

.7-8

.2-7

.8-5

.8-5

.5(%

of

no

min

al p

rod

uct

ion

GD

P e

x m

igra

nts

’ tra

nsf

ers

)-3

.3-2

.6-2

.3-4

.7-5

.4-6

.2-8

.3-7

.8-6

.0-5

.8

e =

est

ima

teE

rro

rs in

ad

din

g u

p t

he

cu

rre

nt

acc

ou

nt

are

du

e t

o r

ou

nd

ing


Tabl

e H

Labo

ur m

arke

t

Act

uals

Pro

ject

ions

Mar

ch y

ear

1992

1993

1994

1995

1996

1997

1998

e19

9920

0020

01

Ch

an

ge

in la

bo

ur

forc

e:

Na

tura

l in

cre

ase

(0

00

’s)

17

.51

3.7

15

.41

6.1

16

.31

6.7

19

.71

6.1

16

.21

6.2

Ne

t m

igra

tion

(0

00

’s)

1.7

2.8

6.5

9.2

13

.09

.1-0

.2-3

.7-0

.13

.0In

cre

ase

in p

art

icip

atio

n (

00

0’s

)-1

0.0

-14

.52

7.9

9.6

29

.30

.1-3

.61

3.8

11.0

7.3

Tota

l ch

an

ge

in la

bo

ur

forc

e (

00

0’s

)9

.12

.14

9.8

34

.85

8.6

25

.91

5.9

26

.12

7.1

26

.5

Mar

ch q

uart

er

Po

pu

latio

n o

f w

ork

ing

ag

e (

00

0’s

)2

57

42

60

02

63

42

67

32

71

82

75

72

78

72

80

52

82

92

85

8L

ab

ou

r fo

rce

pa

rtic

ipa

tion

ra

te (

%)

63

.86

3.2

64

.36

4.7

65

.76

5.7

65

.66

6.1

66

.56

6.8

Tota

l la

bo

ur

forc

e (

00

0’s

)1

64

11

64

31

69

31

72

81

78

71

81

31

82

81

85

51

88

21

90

8

Tota

l em

plo

yme

nt

(00

0’s

)1

46

01

47

51

53

21

60

81

67

11

68

81

69

11

71

01

75

31

79

3A

nn

ua

l gro

wth

(%

)-0

.81

.03

.95

.03

.91

.10

.11

.22

.52

.3

Un

em

plo

yme

nt

(00

0’s

)1

81

16

81

61

12

011

61

24

13

81

44

12

811

5U

ne

mp

loym

en

t ra

te11

.11

0.2

9.5

6.9

6.5

6.9

7.5

7.8

6.8

6.0

Un

em

plo

yme

nt

rate

(s.

a.)

10

.69

.89

.16

.66

.16

.47

.17

.46

.55

.7

Tota

l ho

urs

wo

rke

dA

nn

ua

l gro

wth

(%

)0

.42

.83

.46

.24

.3-2

.2-0

.52

.32

.32

.1

La

bo

ur

pro

du

ctiv

ityA

nn

ua

l gro

wth

(%

)1

.1-0

.52

.20

.0-0

.21

.32

.62

.11

.61

.3

QE

S p

riva

te s

ect

or

wa

ge

s ($

pe

r h

ou

r)1

4.0

14

.11

4.3

14

.61

5.1

15

.71

6.2

16

.61

7.1

17

.6A

nn

ua

l gro

wth

(%

)2

.80

.71

.42

.13

.74

.02

.92

.82

.92

.8

e =

est

ima

te


Tabl

e I

Sho

rt-t

erm

pro

ject

ions

(Qu

art

erl

y p

erc

en

tag

e c

ha

ng

es,

un

less

sp

eci

fied

oth

erw

ise

)

Act

uals

/Est

imat

esP

roje

ctio

nsQ

uart

erly

ave

rage

Dec

-96

Mar

-97

Jun-

97S

ep-9

7D

ec-9

7M

ar-9

8Ju

n-98

Sep

-98

Dec

-98

Mar

-99

Pric

e m

easu

res

CP

IX0

.70

.20

.30

.70

.50

.30

.20

.40

.40

.5C

PI

0.7

-0.3

0.1

0.5

0.6

0.2

0.3

0.3

0.4

0.2

Wa

ge

s0

.61

.41

.00

.60

.40

.91

.00

.30

.41

.1H

ou

se p

rice

s2

.72

.30

.90

.61

.4-1

.0-0

.7-0

.5-0

.20

.0C

on

stru

ctio

n c

ost

s (r

esi

de

ntia

l)0

.40

.21

.01

.41

.40

.50

.20

.00

.10

.2Im

po

rt p

rice

s-0

.9-0

.70

.12

.50

.63

.21

.60

.20

.2-0

.5

Mon

etar

y co

nditi

ons

(leve

l)N

om

ina

l MC

I1

00

09

56

89

77

46

65

65

50

37

53

50

27

52

25

TW

I6

7.1

68

.46

8.0

64

.86

3.9

61

.25

9.0

58

.75

8.4

58

.59

0-d

ay

rate

8.9

7.5

7.2

8.1

7.9

8.9

9.1

9.1

8.5

8.0

Out

put a

nd e

mpl

oym

ent (

seas

onal

ly a

djus

ted)

GD

P (

pro

du

ctio

n)

0.8

-0.4

1.4

0.6

0.5

0.2

0.4

0.7

1.0

0.9

Tota

l em

plo

yme

nt

-0.5

0.0

0.1

-0.1

0.3

-0.2

0.0

0.1

0.3

0.8


CPIX Consumers Price Index excluding Credit Services.Consumers Price Index.

TWI RBNZ. Nominal Trade Weighted Index of the exchangerate. Defined as: a geometrically-weighted index of theNew Zealand dollar bilateral exchange rates of Australia,Japan, United States, United Kingdom and Germany.

90-day rate RBNZ. Defined as: the interest yield on 90-day bankbills.

Nominal MCI RBNZ. Defined as: {(90day-r0) + (1/2)*[logn(TWI) -logn(TWI0)]*100}*100 + 1000 where 90day and TWI arenominal rates and r0 and TWI0 are correspondingaverages of daily rates for the December 1996 quarter,where r0 = 8.91 and TWI0 = 67.11.

Real MCI RBNZ. Defined as: {(R90day-R0) + (1/2)*[logn(RTWI) -logn(RTWI0)]*100}*100 + 1000 where R90day andRTWI are the estimated real 90-day interest rate and thereal TWI exchange rate. R90day is calculated as thenominal 90-day rate less the annual (four quarter)inflation rate in the CPIX. RTWI is calculated as theTWI multiplied by New Zealand’s GDP deflator(interpolated from annual data) and divided by the trade-weighted average of GDP deflators of our tradingpartners. R0 and RTWI0 are base levels for the December1996 quarter, where R0 =6.5 and RTWI0 = 1(normalised). All input numbers are rounded to onedecimal place.

Industrial production Actuals sourced from OECD. Projections based onConsensus Forecasts.(Currently adjusted by a 14-country index over theprojection period.) Seasonally adjusted.

World CPI inflation RBNZ definition and estimate: TWI trading partners’CPI inflation, weighted by TWI weights. Projectionsbased on Consensus Forecasts.

Import prices Domestic-currency import prices. Overseas Trade Index.Export prices Domestic-currency export prices. Overseas Trade Index.Terms of trade Constructed using domestic-currency export and import

prices, Overseas Trade Indices.World 90-day rate RBNZ definition and estimate: 80:20 weighted

combination of US and Australian short-term (90-day)interest rates. Projections based on ConsensusForecasts.

World bond rate RBNZ definition and estimate: 80:20 weightedcombination of US and Australian long-term (10 year)interest rates. Projections based on Consensus Forecasts

Private consumption System of National Accounts.Public authority consumption System of National Accounts.Residential investment RBNZ definition: private sector and government market

sector residential investment. System of NationalAccounts.

Business investment RBNZ definition: total investment less the sum of non-market investment and residential investment. System ofNational Accounts.

Appendix 5: Notes for the tables


Non-market investment RBNZ definition: System of National Accounts annualnominal Government non-market/market investmentratio interpolated into quarterly data. This ratio is usedto split real quarterly expenditure GDP GovernmentInvestment into market and non-market.

Final domestic expenditure RBNZ definition: the sum of total consumption and totalinvestment. System of National Accounts.

Stockbuilding Percentage point contribution to the growth of GDPmade by SNA stocks. System of National Accounts.

Gross national expenditure Final domestic expenditure plus stocks. System ofNational Accounts.

Export of goods and services System of National Accounts.Imports of goods and services System of National Accounts.GDP (production) System of National Accounts.Potential Output Reserve Bank of New Zealand definition and estimate.

Refer to: Conway, P. and B. Hunt, (1997), ‘Estimatingpotential output: a semi-structural approach’, ReserveBank of New Zealand Discussion Paper, G97/9.

Output gap RBNZ definition and estimate: the percentage differencebetween real GDP (production, seasonally adjusted) andpotential output GDP.

Compensation of employees Household Income and Outlay Accounts.Other income Household Income and Outlay Accounts.Nominal disposable income Household Income and Outlay Accounts.Consumption deflator System of National Accounts.Real disposable income Household Income and Outlay Accounts.Real household consumption System of National Accounts.Household savings rate Household Income and Outlay Accounts.Direct taxation Historical source: The Treasury. Defined as total

personal taxation, total company taxation and totalwithholding taxes. Adjusted by the RBNZ over theprojection period.

Indirect taxation Historical source: The Treasury. Adjusted by the RBNZover the projection period.

Non-tax revenue Historical source: The Treasury. Adjusted by the RBNZover the projection period.

Total expenses Historical source: The Treasury. Adjusted by the RBNZover the projection period.

Net surplus attributable to SOEs andCrown entities The Treasury.Government operating balance Percentage of nominal GDP (expenditure), June year.Net public debt Historical source: The Treasury. Projection adjusted for

the difference between The Treasury and RBNZ’soperating balance forecasts.

Plant and machinery investment RBNZ definition: market sector plant and machineryinvestment. System of National Accounts.

(excluding computers) RBNZ definition: market sector plant and machineryinvestment excluding computer investment. System ofNational Accounts.

Transport equipment RBNZ definition: market sector transport equipmentinvestment. System of National Accounts.

Commercial buildings RBNZ definition: market sector non-residential buildinginvestment. System of National Accounts.


Other investment RBNZ definition: market sector other construction andland improvement investment. System of NationalAccounts.

Total market investment RBNZ definition: the sum of total business investmentand total residential investment. System of NationalAccounts.

Total investment System of National Accounts. (excluding computers) Total investment less computer investment. System of

National Accounts.Export of goods System of National Accounts.Export of services System of National Accounts.Import of goods System of National Accounts.Import of services System of National Accounts.Merchandise trade balance Balance of Payments.Services balances Balance of Payments.Investment income balance Balance of Payments.Transfers balance Balance of Payments.Current account balance Balance of Payments.Natural increase Defined as the change in the population of working age

minus net migration.Net migration Net arrivals of working age (15-64). External Migration.Participation rate Household Labour Force Survey.Labour force Household Labour Force Survey.Total employment Household Labour Force Survey.Unemployment rate Household Labour Force Survey.Total hours worked Household Labour Force Survey.Labour productivity Defined as GDP (production) divided by HLFS hours

worked. This series is smoothed by taking a four quartermoving average.

Wages Private sector ordinary time average hourly earnings,Quarterly Employment Survey.

House prices Average house price index, Valuation New Zealand.Construction Costs (residential) Component of the Housing Group, Consumer Price

Index.Quarterly percentage change (Quarter/Quarter-1-1)*100Annual percentage change (Quarter/Quarter-4-1)*100Annual average percentage changeAlso defined as: annual average % change.

(Year/Year-1-1)*100Source: Unless otherwise specified, all data conform to Statistics

New Zealand definitions, and are not seasonallyadjusted.

Documents

Monetary Policy Statement - rbnz.govt.nz · RESERVE BANK OF NEW ZEALAND: Monetary Policy Statement 1 ... with a substantial tax cut bolstering increases in real wages. The one-off