Transcript Inflation and Monetary Policy

Inflation and Monetary Policy
The NZ Financial System
Government Banks
with
Reserve Bank of New Zealand
(RBNZ)
Registered banks:
e.g. ANZ, BNZ. Westpac etc
The Public Banks
with
Non-Bank deposit-taking institutions
e.g. saving institutions, finance
companies
Maintaining Price Stability
• The Reserve Bank ensures that money retains its buying
power.
– It is responsible for maintaining price stability i.e. guarding
against inflation or deflation in order to protect the value of
people’s incomes and savings.
Inflation = an increase in the general level of prices over a
period of time.
Inflation = Change CPI x 100
Original CPI
e.g.
Year
CPI
Inflation = 1010 – 985 x 1000
2006
985
985
2007
1010
= 2.54%
Inflation, Disinflation and Deflation
• Inflation = increase in general price level
• Disinflation = rate of inflation is decreasing
• Deflation = decrease in average price level
% change in price level
+ve
-ve
B
A
C
Years
Text Book Activity C3.6
D
Page 325 10mins
Why do we need stable prices?
• Key reason is to keep export prices competitive.
• Rising prices make NZ exports more expensive compared
with competing products
Low inflation also means
 Businesses can plan for the future
 People are encouraged to save rather than borrow
 Firms more likely to invest in new production
 Wages and prices are consistent
Policy Targets Agreement
• The Reserve Bank’s responsibilities
are set out in the Policy Targets
Agreement: a contract between the
Minister of Finance and the
Governor of the RBNZ
Policy Targets Agreement:
required to keep inflation
between 1% and 3% in the
medium term.
Monetary Policy
• Monetary Policy – Changing interest rates or the
money supply to influence the level of economic
activity.
Official
Cash Rate
Monetary
Policy
Tools
Open
Market
Operations
Moral
Suasion
Monetary Policy
• Official Cash Rate (OCR) – Interest rate set by
the Reserve bank to implement monetary policy,
so as to maintain price stability
The Reserve Bank in NZ now directly influences interest rates using the
OCR.
By setting the OCR the RBNZ is able to substantially influence short term
interest rates.
Short term interest rates have a big impact on
the overall level of economic activity in the
country and therefore on inflation.
Influence on Interest rates by OCR
• The reserve bank pays financial institutions
0.25% below the OCR for money deposited
in the Reserve Bank settlement accounts
• The reserve bank charges interest at 0.25%
above the OCR for overnight cash to banks.
• The Reserve Bank also sets
no limit on the amount of cash
it will take in or let out.
OCR
• The Reserve Bank reviews the OCR eight
times a year.
• Only in exceptional circumstances would
the Reserve Bank make unscheduled
adjustments to the OCR.
• The OCR is much more simpler and easier
understood than earlier systems.
Effects of the OCR
Reserve Bank increases OCR from 2.5% to 3%
Financial Institutions pay 3.25% on loans, up from 2.75%
Financial Institutions get 2.75% on settlement accounts up from 2.25%
Various Financial Institutions will then increase their own interest rates to
consumers and producers.
Consumption rate falls as consumers will begin to save more.
Investment will fall as producers pay more interest on loans
Aggregate demand for goods and services in the economy falls
The Inflation Rate will fall
Monetary Polices
• Loose Monetary Policy
– Lowering the OCR to stimulate the economy
and encourage economic growth
• Tight Monetary Policy
– Increasing the OCR to dampen economic
activity
Open Market Operations (OMO)
• The buying and selling of government securities (bonds) in
the open market in order to expand or contract the amount
of money in the banking system.
Purchases by the government of
government bonds owned by banks
inject money into the banking system and
stimulate growth
Sales of government bonds by the
government withdraw money from the
banking system and contract the economy.
Sell stock to reduce money supply
and buy back stock to increase money
supply
http://www.nzdmo.govt.nz/securities/govtbonds
Moral Suasion
• The Reserve Bank lets the market know about
what its expectations are for the future.
• This then lets markets predict as to what the
RBNZ might do in the future and thus people will
change behaviours to favour themselves in the
future.
• The RBNZ Monetary Policy
Statements are one example
of how the RBNZ tells the
financial markets (banks etc) about its actions.