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This paper uses the open economy structural VAR model developed in Buckle, Kim, Kirkham, McLellan and Sharma (2002) to evaluate the impact of monetary policy on New Zealand business cycles and inflation variability and the output/inflation variability trade-off. The model includes a forward-looking Taylor Rule to identify monetary policy and the impact of monetary policy is evaluated by deriving a monetary policy index using a procedure suggested by Dungey and Pagan (2000). Monetary policy has generally been counter-cyclical, thereby reducing business cycles and inflation variability. Exceptions are in 1994 and 1995 when monetary policy accentuated the business cycle upswing and in 1998 when monetary policy accentuated the recession, although its impact in 1998 was small relative to the impact of adverse climatic conditions. During the initial years of inflation targeting monetary policy tended to simultaneously reduce inflation and output variability. From 1996 to 2001 monetary policy was less effective in reducing inflation and output variability. This latter period included a brief experiment with a Monetary Conditions Index, the Asian crisis and a large adverse domestic climate shock.
The authors thank Iris Claus, John Creedy, Mardi Dungey, Arthur Grimes, David Hargreaves, Alfred Haug, Ozer Karagedikli, Chris Plantier and Brendon Riches for helpful discussions and suggestions during the preparation of this paper. Comments from participants at a New Zealand Econometrics Study Group meeting in August 2002 and a Reserve Bank of New Zealand seminar in June 2003 are gratefully acknowledged. Thanks are also due to Jenny Fenwick and David Law for their assistance with the preparation of diagrams and formatting.
The views expressed in this Working Paper are those of the author(s) and do not necessarily reflect the views of the New Zealand Treasury. The paper is presented not as policy, but with a view to inform and stimulate wider debate.
Table of Contents
- 1 Introduction
- 2 A structural VAR model of the business cycle
- 3 Identifying monetary policy
- 4 Contributions to New Zealand growth cycles
- 5 The impact of monetary policy on the growth cycle and inflation
- 6 Inflation targeting and the output/inflation variability trade-off
- 7 Conclusions