RBNZ Looks At Estimated Taylor Rules Post GFC

Here’s a new note from the Reserve Bank looking at estimated Taylor rules post GFC.

A Taylor Rule is a way to describe how a central bank changes short-term interest rates through the policy rate in response to changes in economic conditions.

There is an interesting finding the Australia and New Zealand conduct monetary policy in a similar fashion. Kendall and Ng say that this could be because Australia and New Zealand have achieved a level of price stability that means deviations from inflation expectations are expected to be short lived so there isn’t a need to respond as aggressively as a strong form Taylor Rule might suggest.



The Reserve Bank started inflation targeting and now most central banks use an inflation targeting model and other factors like financial stability in order to conduct monetary policy.

Look at the long term trend for interest rates in light of the previous graph.






Since the GFC hit the unexplained part of short term interest rates has been significant. This suggests that either the monetary policy rule has changed or there has been a substantial structural changes in the economy.

This basically means that NZ has had a lower policy rate than expected since the GFC struck. Kendall and Ng think that changes in bank funding costs, household deleveraging and even a view that investment returns will be lower could explain the gap.

This is a very interesting piece of analysis. While there isn’t a large amount of data to work with considering that the crisis period only started in 2008, it is very helpful stuff.

What I think the most interesting part of the note is the explanation that achieving a reasonable level of price stability means that aggressive policy rate responses to deviations from inflation expectations aren’t necessary because agents trust the central bank and don’t think deviations from inflation expectations will last long.

In Plain English, it means that inflation targeting and focusing on price stability has worked very well for New Zealand. It would be nice if housing bubble types focused on the supply and demand story instead of trying to attack the independence of the Reserve Bank.