In early 2021, the Reserve Bank of New Zealand (RBNZ) faced intense debates regarding the effectiveness of its monetary policy framework amidst global supply chain disruptions and a booming domestic housing market. Historically, New Zealand was the first country to formally adopt inflation targeting in 1990, setting a precedent globally.
A persistent issue for the RBNZ was balancing its dual mandate of supporting maximum sustainable employment while maintaining price stability. High levels of household debt and elevated asset prices meant that raising interest rates to combat rising price pressures could severely dent consumer spending and trigger a recession.
Despite these risks, global commodity price spikes and domestic labor shortages pushed consumer prices upward. Between March 2021 and March 2022, New Zealand’s Consumer Price Index (CPI) rose from 112.5 to 120.6. When a central bank's inflation target is credible, it anchors the long-term price-setting behavior of firms and wage demands of workers. However, maintaining this anchor is difficult when the economy is hit by severe supply-side shocks, such as rising shipping costs or agricultural disruptions, which lie largely outside the control of domestic monetary policy.
The RBNZ operates with an explicit inflation target range of 1% to 3%, with a focus on keeping future inflation near the 2% midpoint. Fig. 1 outlines New Zealand's CPI inflation rates from 2014 to 2023 relative to this target band.
| Year | CPI Inflation Rate (%) | Target Range Performance |
|---|---|---|
| 2014 | 1.1% | Within target |
| 2015 | 0.2% | Outside target (Below) |
| 2016 | 0.6% | Outside target (Below) |
| 2017 | 1.9% | Within target |
| 2018 | 1.6% | Within target |
| 2019 | 1.6% | Within target |
| 2020 | 1.7% | Within target |
| 2021 | 3.9% | Outside target (Above) |
| 2022 | 7.2% | Outside target (Above) |
| 2023 | 4.7% | Outside target (Above) |
Using information from the stimulus material, evaluate whether setting an inflation rate target is likely to result in low and stable inflation.
