A Brief History of Monetary Policy Objectives and Independence in New Zealand
Graham, James, Smith, Christie, The Reserve Bank of New Zealand Bulletin
Views about the appropriate role for monetary policy, and the appropriate legal relationship between the government and the Reserve Bank, have evolved considerably since the Reserve Bank's inception in 1934. In this article we outline the evolution of the legislative objectives for monetary policy in New Zealand and the changing nature of the Reserve Bank's statutory responsibility for monetary policy.
The statutory objectives governing monetary policy and the Reserve Bank's independence have been repeatedly modified since the 1930s. These provisions have been influenced by differing domestic political emphases and by the evolution of economic thought about what monetary policy can usefully achieve. The current form of the legislative provisions governing monetary policy was also extensively influenced by the rethinking of wider public sector governance in New Zealand in the late 1980s. Although New Zealand's approach to monetary policy has evolved in much the same way as in other countries, many of the details of our framework have retained a distinctly New Zealand flavour.
At inception, the purpose of the Reserve Bank was to manage money and credit conditions to promote New Zealand's economic welfare. An integral part of this was the requirement that the Reserve Bank maintain the New Zealand pound's convertibility into the British pound. In subsequent amendments and acts between 1936 and 1964, the number and scope of monetary objectives expanded--variously encompassing economic and social welfare, production, trade, employment, and price stability, though not necessarily in that order. Eventually, with the floating of the New Zealand dollar in 1985 and the passage of the Reserve Bank Act 1989, the primary objective of monetary policy settled on domestic price stability, (2) under the implicit, oft-repeated, understanding that monetary policy pursuing price stability provided the best possible contribution to the economic welfare of New Zealand.
The legal independence of the Reserve Bank in respect of monetary policy has also been amended over its history. The Bank was granted a high degree of formal independence under the inaugural Reserve Bank Act of 1933, but this independence was substantially removed later in the 1930s and in other subsequent amendments to the Reserve Bank Act. The 1989 Act put in place a balanced arrangement in which the Reserve Bank has full operational autonomy in the conduct of monetary policy, while the Minister of Finance has considerable (transparent) involvement in agreeing how price stability should be pursued, and some reserve powers of intervention.
2 The responsibility of a new central bank
By the late 1920s, most countries were once again part of the Gold Standard, with national currencies being convertible into gold at a fixed price. For example, the UK, New Zealand's most important trading partner, returned to the Gold Standard in 1925, following its temporary suspension during World War I. Convertibility of paper currency into gold was seen as a basic feature of sound money in this era, establishing confidence in the currency and promoting macroeconomic stability.
Until the late 1920s, New Zealand trading banks managed domestic credit conditions to maintain a de facto fixed exchange rate close to parity between the New Zealand pound and the British pound (Hawke, 1973, pp 17, 19). Prior to the establishment of the Reserve Bank in 1934, trading banks in New Zealand issued their own bank notes. Before World War I, these notes were convertible to gold upon request (Wright 2006, p 6).
Concerns about foreign reserves and domestic credit provided an impetus for the establishment of a central bank. In the late 1920s, four of New Zealand's six trading banks were Australian owned. These four banks held common pools of sterling reserves for the two countries, which led some to believe that adverse macroeconomic conditions in Australia were constraining credit conditions and the availability of foreign exchange for New Zealand (Ashwin, 1930). …