Flexibility and the limits to inflation targeting

This article reproduces the paper for a speech given by Governor Alan Bollard on 30 July 2008. We argue that New Zealand’s flexible inflation-targeting framework serves the economy well, but one should not to ask too much of it. Inflation targeting is the best approach New Zealand and many other similar countries have yet found for monetary policy, among a limited number of viable alternatives. The fact remains that the New Zealand economy is subject to powerful forces, and monetary policy can only do so much to buffer the shocks. When shocks are persistent, as with oil and food prices currently, it is difficult to judge the appropriate response. Monetary policy needs to allow the initial price changes to occur, but be firm enough to ensure that generalised second-round inflation effects do not take hold.