ROLE OF RESERVE BANK OF NEW ZEALAND IN ECONOMIC STABILITY

The Reserve Bank of New Zealand (“RBNZ”) is the nation’s central bank, founded in 1934. The New Zealand Government has full control over this bank. Its powers and functions are governed by the Reserve Bank of New Zealand Act 1989. It is responsible for ensuring the stability of the New Zealand dollar (“NZD”) and promoting economic growth. It plays an important role in maintaining the economic stability of the Country by employing several tools and policies including monetary policy operations, monitoring, and supervising registered banks to ensure the financial system’s stability.

MONETARY POLICY

The primary objective of the RBNZ’s monetary policy is to maintain price stability. The monetary policy framework of New Zealand is traditional. The Monetary Policy Committee is the decision-making body within the Reserve Bank which is responsible for formulating monetary policy. It involves using interest rates to target a specified inflation rate to provide a stable environment for business investment and economic growth. The Reserve Bank Act 1989 mandates the RBNZ to keep inflation between 1-3% on average over the medium term, focusing on maintaining perspective average inflation around the 2% target midpoint and supporting maximum sustainable employment.

1.Inflation Targeting

Inflation targeting involves adjusting the Official Cash Rate (“OCR”), which influences the interest rates across the economy. The OCR influences the wholesale price for borrowing or lending for New Zealand’s registered banks.  The banks pay interest on any funds borrowed from the Reserve Bank (at a rate 50 basis points above the OCR) and receive interest on any overnight funds deposited with the Reserve Bank (at the OCR up to a certain value, and then at an interest rate 100 basis points below the OCR).

By increasing the OCR, the RBNZ can curb excessive demand and inflation. As interest rates rise, people reduce their household consumption and demand for goods and services which in turn places downward pressure on prices and therefore reduces inflation while the opposite occurs when interest rates decline. This strategy seeks to provide a stable economic climate so that consumers and businesses may make wise financial decisions.

2. Challenges

This change in monetary policy takes a year or more to reflect in the economy or to show the desired impact on inflation. By communicating its future policy intention, the bank can influence expectations and behaviour in the economy.

FINANCIAL SUPERVISION AND REGULATION

The RBNZ regulates and supervises banking and non-banking financial institutions to ensure that they operate safely and soundly to facilitate economic stability. Financial stability means having a resilient financial system that can sustain significant but conceivable shocks and go on offering the financial services on which we all depend.

1. Prudential Regulation-

The RBNZ imposes prudential regulations including adequate capital requirements for banks and non-bank deposit takers enabling them to continue lending to people and businesses while absorbing unforeseen losses, ensuring liquidity standards for banks so that they can meet their cash-flow demands, ensuring solvency standards for insurers so that they can afford to pay claims.

2. Stress Testing-

The RBNZ conducts regular stress tests on individual financial institutions to determine their resilience to adverse economic scenarios. It will help to evaluate how banks would cope with significant economic downturns.

3. Macroprudential Tools-

To address the risk of financial instability, the RBNZ employs macroprudential tools such as capital and liquidity tools and borrower-based tools. These tools transmit directly to financial stability. Capital tool increases the amount of capital that banks have available to absorb losses. Liquidity tools reduce the vulnerability of banks to disruptions in funding markets. Borrower- based tools restrict the amount of credit that banks can lend to certain borrowers.