Tuesday, March 9, 2010

New Zealand & The OCR

Over the last four to five years the New Zealand government has faced and dealt with a number of different challenges in the New Zealand macroeconomy. These challenges have been meet with policies imposed by the policymakers in order to keep the economy under control. On April 24th, 2008 the Reserve Bank of New Zealand (RBNZ) posted a news release entitled “OCR Unchanged at 8.25 percent”. The statement elaborates on the potential challenges the New Zealand macroeconomy is facing and may face over the next year. These challenges indicate bear market activity for the New Zealand economy, with a decreasing rate of supply, demand, investment and net exports and also the inflationary problem. These challenges arising in the New Zealand macroeconomy are dealt with by the government regularly through the likes of the Official Cash Rate (OCR), exchange rate intervention, taxation, subsidies and tariffs. Each policy is specifically designed to influence one area of the economy, focusing on that area and improving its condition.

The OCR in New Zealand is set by the RBNZ, and regulates the interest rate at which banks can borrow money, thus indirectly setting the personal interest rate for both borrowing and investing. Inflation is a concern in all economies, as it is an increase in the general price level of goods and services, indicating that the value of money has decreased and potentially causes a fall in the standard of living . The rate of inflation in an economy is affected by inflationary factors: money supply, interest rates, consumer demand, cost of production, terms of trade, productivity, overseas prices, the exchange rate and inflationary expectations. A change in the OCR would be directed at influencing the interest rate, potentially decreasing or increasing consumer demand (expenditure), interest rates and investment, thus the money supply (as investment increases the money supply increase and vice versa). However Mr Bollard (Reserve Bank Governor Alan Bollard) has decided to keep the OCR at its current level in order to meet the PTA (Policy Target Agreement) stating that inflation must remain between 1% and 3% on average over the medium term . Although short term inflation is expected to remain at a high level, with prices rising quickly, the RBNZ is confident that the weakened economy in NZ will begin to ease these pressures . According to Allan Bollard the high OCR will be beneficial in the long run by stabilising the economy, which has fallen into uncertainty after the failure of overseas economies, and keeping investment in NZ high by having a high interest rate, thus increasing the money supply.

However the Reserve Bank may wish to consider the short run implications of leaving the OCR at such a level. With the economic doubts cast over economies throughout the world, fuelled by the collapse of financial organisations in America, the government may want to look at stabilising the NZ economy quickly and reduce inflation. Leaving the OCR unchanged at 8.25 percent means that inflation will continue at a high rate pushing the prices of goods and services higher and higher, which will decrease the aggregate demand and supply even more; putting greater pressure on a weakened economy. Although a high OCR means a high rate of return on investments and encourages individuals to invest in the NZ economy, the global economy is in doubt, meaning that investment will be low even with a high rate of return. Therefore it may be better for NZ to ease inflation immediately rather than trying to increase the money supply. The Reserve Bank should consider lowering the OCR to stimulate consumer demand and boost the overall wellbeing of the economy. The government has announced a policy in order to increase disposable income; it will do this by implementing tax cuts. The increased disposable income will allow consumption and investment to increase, thus Y↑=C↑ +I↑+G+NX. The high NZ dollar is also contributing to counter the effects of inflation (high exchange rate) but this causes a decrease in the number of goods exported as they are now relatively expensive, thus Y↑=C↑ +I↑+G+NX↓.

Investment in the NZ economy is decreasing due to the instability in economies around the world. The low level of investment is having a domino effect throughout the economy, decreasing the money supply (as money generation cannot exist without investment) and adding to high inflation rates. The Reserve Bank acknowledges the low investment, saying “There have been sharp falls in consumer and business sentiment…” indicating a decreasing level of consumption as well as investment and the productivity growth rate, causing the standard of living to decrease. However in response to the low investment levels the government can implement several policies to boost this sector of the economy. Tax deductions free up personal income allowing the economy to increase total investment, although a lot of New Zealand’s investments come from overseas. Income tax cuts would not influence foreigners to invest in NZ. In order to do this the government may consider lowering the tax on interest received (further again boosting investment from New Zealanders but also increasing foreign investment in NZ). Alternatively in order to increase the standard of living and investment the central bank may choose to conduct Open Market Operations (OMO), this is when the government buys or sells government bonds to/from the public. When the government chooses to buy back government bonds it causes an increase in the money supply of the country, increasing investment, and consumption. Another way of increasing the money supply is if the RBNZ lowers the reserve ratio, allowing banks to issue more loans to the public. A similar tactic was used in February 2006 to deal with liquidity problems, where the RBNZ increased the Settlement Cash rate to $2000 million . Although the RBNZ has decided to keep the OCR unchanged it is possible, as a last resort, to increase investment from abroad by increasing the OCR to a point where the gains of investment in NZ out weigh the risks of an unstable economy.

The rate of investment and consumption in an economy are closely linked. As well as the decreasing investment the government has to deal with the decreased rate of consumption. Allan Bollard mentioned in his press release that New Zealand’s “Economic activity has weakened more markedly than expected…” but continues on to say that this weakened market does not necessarily have purely negative consequences . The weak NZ economy will help ease the high inflationary rate. The decrease in the short run aggregate demand can easily be fixed through monetary policies, such as personal tax cuts to increase disposable income and increasing the money supply. However the decrease in aggregate supply is not as easily fixed in this case. The “dry summer” recently experienced will shift the short run supply curve to the left, but the high NZ dollar means NZ goods and services are now relatively expensive compared to those of other countries, thus decreasing exports, (↓NX), and increasing wages, due to inflation, will cause a shift in the long run supply curve. For the government to increase New Zealand’s long run gross domestic product (GDP) it may consider decreasing the natural rate of unemployment by imposing a higher minimum wage (which has recently occurred this year), or to subsidise businesses creating capital resources which increase the countries GDP and hence long run supply. A third possible policy would be to fund technological research, as new and more efficient technology increases an economy’s long run productivity. A further alternative to increase the long run supply of New Zealand’s economy is through economic reform, similar to that implemented in the 1980’s and 1990’s. This economic reform reduced the cost of resource allocation, leading to gains in efficiency throughout the economy . The gain in efficiency would increase productivity in the NZ economy, bringing up the GDP and therefore increasing long run supply.

The NZ economy is experiencing a decreased ratio of net exports. This change in the net export ratio can be caused by an increased value of imports or a decreased value of exports. The high exchange rate means that our products are relatively expensive to those from overseas. Because of this the value of our exported goods and services has decreased, decreasing the net exports (↓NX). A decrease in the net exports means that more money is following out of the country than in, relative to the NX ratio before the decrease in exports (for example pretend that before the high dollar NX = $0 meaning the value of exports matched the value of exports, but once the NZ dollar is high NX = $ -2, meaning that for every dollar imported into our economy, $2 exits to foreign economies). This decreases the money supply. Although the Reserve Bank Governor doesn’t go into detail on the decrease in net exports specifically in his statement, he does state that the “persistently strong New Zealand dollar…remains a drag on export growth” . Therefore it is apparent that low net exports are contributed primarily to the exchange rate. A government policy of controlling net exports, and thus increasing the net foreign income, is through the practice of exchange rate intervention. This policy is the most effective way of dealing with a problem with net exports and helps increase the money supply.

Overall these challenges faced by the New Zealand government and RBNZ have the ability to incite a bear market, bringing New Zealand’s economy to it’s knees. However the policies implemented by the government and RBNZ to deal with these challenges help protect the long run economy from, and limit the short run, economic slowdown. With various monetary and fiscal policies including personal and interest tax cuts, open market operations, minimum wage laws, business subsidies, research funding and exchange rate intervention the NZ economy can be spared from the high rate of inflation and decreasing aggregate demand and supply, investment and net exports which weaken our economy.




1) Mankiw, N., Bandyopadhyay, D., Wooding, P. (2006), Principles of Macroeconomics in New Zealand. South Melbourne, Thompson Learning Australia.
2) Macro, M. (1998), Credit, Investments & the Macroeconomy. Cambridge, UK, the Press Syndicate of the University of Cambridge.
3) Reserve Bank of New Zealand. (1986), Financial Policy Reform. Wellington, Hutcheson, Bowman & Stewart Ltd.
4) Reserve Bank of New Zealand, Governor Allan Bollard. (2008), OCR Unchanged at 8.25 percent. Wellington, News Release.


1) Reserve Bank of New Zealand (2006). Low Equity Investment Leaves New Zealand Vulnerable, retrieved 19/05/08, http://www.rbnz.govt.nz/news/2006/2406180.html
2) Reserve Bank of New Zealand (2008). Monetary Policy, retrieved 19/05/08, http://www.rbnz.govt.nz/monpol/
3) Reserve Bank of New Zealand (2008). The Monetary Policy Decision Making Process, retrieved 19/05/08, http://www.rbnz.govt.nz/monpol/review/0096438.html
4) Reserve Bank of New Zealand (2006). Reserve Bank to Raise Settlement Cash Level to $2000 Million, retrieved 19/05/08, http://www.rbnz.govt.nz/news/2006/2406180.html
5) University of Auckland, The. (2008), Econ 111 Macroeconomics Course Book Semester 1 2008, retrieved 19/05/08, http://cecil.auckland.ac.nz/Cecil.aspx?SessionID=5f30089a-3ed3-4762-9232-bdf3d3e0a993&UserID=06461baf-e0c0-4560-861a-4361361e8b6a

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