Inflation will almost certainly increase with supply chain shocks from the conflict in the Middle East. Is our central bank equipped to handle it? 

In a TV interview in 1988, finance minister Roger Douglas plucked a number out of his head: he wanted inflation to be between 0 and 1%. Reserve Bank governor Don Brash added another percentage point to give himself some leeway, and the following year it was enshrined into law with the Reserve Bank Act. 

The Act allowed the minister of finance to fire the Reserve Bank governor for failing to meet the inflation target. The legal mechanisms have changed since and the targets have been adjusted but the underlying principle remains the same: the Reserve Bank’s sole remit is to keep inflation between 1 and 3% with a long term goal of 2%. 

The experiment worked. It was such a good solution for price stability that it became one of New Zealand’s most successful exports. Over 40 countries have adopted inflation targeting, including Australia, Brazil, Canada, the UK, the US and the European Bank.  

In most cases however, these countries adopted the inflation target alongside dual or secondary targets, such as maintaining maximum employment or supporting the government’s economic policies – and they don’t enforce them quite as strictly. 

Coming from the Swedish central bank, newly appointed New Zealand Reserve Bank governor Anna Breman may have been surprised to realise just how fundamentalist New Zealand economists are for the single mandate. As one of our most significant contributions to global monetary policy, it is held up as a holy grail. When Labour introduced a dual mandate for employment in 2018, National and Act campaigned strongly against it and repealed it as soon as they got into government. 

Developing countries have found strict single mandates particularly useful when they are desperate to assure the world that they are stable and won’t fall into hyperinflation. Versions of the policy have been successfully implemented in Brazil, Peru, and Ghana. 

At the time it was implemented, New Zealand had faced two decades of high inflation peaking at 19%. Inflation was an existential threat to the economy, and it was dealt with firmly. The recent inflation spike in the wave of the Covid-19 pandemic has unearthed some old trauma. 

A strict and limited single mandate is an effective tool, but it’s a blunt one that offers less ability to manoeuvre when facing some economic challenges. And we could be about to face one of those challenges. 

New Zealand’s most recent quarterly inflation figure was 3.1%, just marginally outside the target. The Reserve Bank’s most recent decision – the first of governor Anna Breman’s reign – was to hold the official cash rate (OCR) at 2.25%.

After years of struggle, the New Zealand economy is finally starting to see some green shoots of growth, but if inflation goes any higher then the bank will be forced to increase the OCR. Interest rates will go up, spending will reduce, and we could go back into a recession. 

The war in Iran makes higher inflation highly likely. Cost pressures in oil and supply chain disruption will increase the costs of petrol and many consumer goods. That will be counted in the consumer price index (CPI) as an increase in inflation but it will have nothing to do with the domestic economy. 

In response, the Reserve Bank will be expected to raise the OCR to bring down inflation. But that will just punish a struggling New Zealand economy without doing anything to address the issue. Higher interest rates will drive down local consumer and business spending. 

A higher OCR will help somewhat with internationally-driven inflation because it tends to raise the value of the New Zealand dollar, making imports cheaper. But it will come at the expense of exporters – especially farmers – and won’t do anything to change the amount of oil being shipped around the world. Petrol will still be expensive, and the country is more likely to be in recession. 

A Reserve Bank spokesperson told The Spinoff they couldn’t comment on what the bank might do in a hypothetical future scenario but said they were “closely monitoring and assessing the situation in the Middle East”.

It would arguably be better to allow some higher medium-term inflation than manufacture another recession, but the Reserve Bank can’t do that. The lack of flexibility in its mandates could cause it to make a non-optimal decision. 

When asked whether the Reserve Bank needed more flexible powers to respond to the situation, a spokesperson for finance minister Nicola Willis told The Spinoff the government had no plans to change the Reserve Bank’s mandate. 

Act’s finance spokesperson Todd Stephenson (whose party sees Roger Douglas as a literal and philosophical forefather) defended the single mandate: “The Reserve Bank should not ignore or deprioritise its mandate,” he said.

“If the Bank was seen to take its eye off the inflation ball, this would impact inflation expectations, risking an inflation spiral. I’d also point out that inflation was already outside of the target range before the Iran war began. We shouldn’t rush to make excuses for the Reserve Bank – we should expect it to do its job.”

Although Labour introduced the dual mandate, it hasn’t fought particularly hard for its return. It’s not exactly a kitchen table issue on the minds of the median voter. When asked for her views, finance spokesperson Barbara Edmonds offered this string of words: “Decisions about the official cash rate are for the independent Reserve Bank. While international factors are pushing up costs around the world, New Zealand families have been struggling even before the conflict began. Christopher Luxon promised he’d fix it, but he’s only made things worse.”

Green co-leader Chlöe Swarbrick argued that the difference between a single and dual mandate was overblown. “The single mandate is bullshit. It’s not real, it hasn’t changed anything,” she said. “I’ve asked multiple Reserve Bank governors whether it would have changed their decisions if they had [a single mandate] and time and again they have said ‘no’.” 

The Greens feel that Labour and National-led governments have overstated the impact of Reserve Bank decisions and underestimated the impact of government spending decisions. They want the government to take a more active role in using fiscal policy to manage the economy. 

Politically, it seems there is little appetite to change the bank’s mandate. So New Zealand flies onward, into the coming storm, brandishing one of the bluntest instruments in world finance, to tackle one of the most complex issues in geopolitics. Let’s hope it works out fine.