Inflation expectations and monetary policy

14 March 2016

Inflation expectations and monetary policy

The Reserve Bank today published a Bulletin article, ‘Inflation expectations and the conduct of monetary policy in New Zealand’. This article discusses some useful tools the Bank has developed to assess the policy implications of inflation expectations, highlights recent trends in inflation expectations, and draws out the implications for current monetary policy settings in New Zealand.

“Inflation expectations are a key issue for monetary policy at the moment. Inflation expectations have fallen significantly recently across a range of measures, and this is a concern for the Bank, contributing to the need for low interest rate settings,” Assistant Governor and Head of Economics, Dr John McDermott, said today.

Dr McDermott said that, despite their importance for monetary policy, inflation expectations are difficult to measure in practice.

“There is no one best measure of inflation expectations. Instead, the Bank looks at a wide range of measures.”

Dr McDermott said that there are a number of considerations the Bank makes when interpreting measures of inflation expectations.

“One important aspect is the influence that inflation expectations will have on wage and price setting behaviour at horizons relevant for forecasting inflation and setting monetary policy.

“A further important aspect is if inflation expectations are well anchored. Well-anchored inflation expectations are an important component of inflation targeting.”

Dr McDermott highlighted that the Bank has a number of useful tools to help summarise the diverse range of inflation expectations measures. These include the Bank’s heat map system and the inflation expectations curve. Today’s Bulletin article and a related Analytical Note, ‘Inflation expectations curve: a tool for monitoring inflation expectations’ discuss these tools in further detail.

Dr McDermott said that recent trends in inflation expectations have a number of important implications for current monetary policy.

“There has been a material decline in inflation expectations recently, which risks becoming embedded in future wage and price decisions. This is one factor contributing to the current need for low interest rate settings. Low interest rate settings will help offset the dampening impact low inflation expectations will have on today’s wage and price setting behaviour. They will also help ensure inflation expectations remain well anchored. If the recent material decline in a broad range of inflation expectations measures continues, the Bank would need to reconsider the outlook for interest rates.”

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