The Business Cycle, Housing and the Role of Policy: Summary of a Recent Conference Held by the Treasury and the Reserve Bank of New Zealand

By Buckle, Robert A.; Drew, Aaron | The Reserve Bank of New Zealand Bulletin, March 2008 | Go to article overview

The Business Cycle, Housing and the Role of Policy: Summary of a Recent Conference Held by the Treasury and the Reserve Bank of New Zealand


Buckle, Robert A., Drew, Aaron, The Reserve Bank of New Zealand Bulletin


Background

Since the mild recession in 1997, New Zealand has experienced the strongest and longest economic expansion on record. This lengthy growth phase and the very high rates of employment in the economy is an excellent outcome. The growth pattern has, however, been associated with a number of economic 'imbalances' and strong inflationary pressure, requiring a tight monetary policy stance. Over this decade, the exchange rate has also appreciated from record lows against the US dollar to record highs.

The appreciation of the exchange rate and the associated imbalances have been a concern for many and, in particular, have led to questions over whether an alternative mix of policy and the use of additional policy instruments might result in smaller swings in the exchange rate, whilst still maintaining low and stable inflation and good growth outcomes.

The Reserve Bank of New Zealand, The Treasury and other agencies have over the past few years sought to better understand the key forces influencing this business cycle, including the roles of monetary, fiscal and other policies. In 2006, international macroeconomic policy experts were invited to New Zealand to share their views on New Zealand's macroeconomic situation and its macroeconomic policy framework and practice (Buckle and Drew, 2006). Although the broad macroeconomic policy frameworks were generally regarded as sound, several areas of research were suggested for follow-up, including investigating the monetary policy transmission mechanism, the influence of fiscal policies, the roles that fiscal and prudential policies might play in macroeconomic stabilisation, and investigating the influences of recent large swings in the New Zealand housing market. In December 2007, the Reserve Bank and The Treasury hosted a follow-up workshop where research in these areas was presented. In this article we summarise the themes and insights from this workshop and suggest areas for future work. Access to most of the papers from the workshop is available from the Reserve Bank's website at www.rbnz.govt.nz.

Themes and insights

The business cycle and the roles of policies

Over the first day of the workshop, the focus was on 'shocks' that have shaped the recent business cycle and the role of macroeconomic and prudential policies.

The day began with a paper by Drew et al. (2008) that investigates the mechanism by which monetary policy is transmitted to the economy. The paper gives particular attention to how this mechanism has changed over the past decade. This has been a topic of some public debate in New Zealand, with some arguing that monetary policy transmission has either weakened or the lags are longer (see, for example, Grenville, 2006 and Allsopp, 2006). The key finding of Drew et al. (2008) is that monetary policy transmission has not obviously weakened, and in some areas has strengthened, over the past decade. This implies that the scope for the Reserve Bank of New Zealand to run an independent monetary policy remains as strong as ever. Evidence is also presented that suggests the exchange rate has become more responsive to interest rate changes over recent years. However, the impact of exchange rate changes on inflation and domestic activity has weakened somewhat.

A paper by Dungey and Fry (2008) estimates the contributions of monetary policy, fiscal policy, and other domestic and international 'shocks' to the New Zealand business cycle. Building on previous New Zealand business cycle modelling research, several interesting findings emerge from this work. First, output and inflation are found to be much more affected by demand and supply shocks, such as swings in the terms of trade, than by monetary and fiscal policies. Second, estimates suggest that fiscal policy (including both the so-called automatic stabilisers and discretionary fiscal policy shifts) tend to have significantly larger impacts on the economy than monetary policy. …

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