Long-run mean reversion in asset market returns is one of a set of core 'investment beliefs' of the Guardians of the New Zealand Superannuation Fund (NZSF). These beliefs underpin the investment strategies of the Fund. In this chapter, we present a dynamic portfolio asset allocation strategy that we call 'strategic tilting' which aims at exploiting the mean reversion process in asset markets. It is one of a set of portfolio strategies that the NZSF regards as a source of additional value over market returns. Strategic tilting involves adjusting (or tilting) exposures to broad asset classes around their benchmark weights in the strategic asset allocation (SAA) according to their relative return prospects.

The investment beliefs of funds (whether explicit or implicit) tend to fall into two groups - those that imply there should be very little deviation from listed markets benchmarks and those that imply that the asset allocation and risk-profile should be allowed to deviate substantively to capture expected excess risk-adjusted returns. In practice, however, most funds do not deviate substantively from their benchmarks, regardless of their investment beliefs. Based on discussion with our asset managers and peer funds, we attribute the main reason for this is that it is difficult to sustain strategies that result in losses relative to benchmarks even if ex-ante the strategy is expected to add-value given sufficient time. Drawing on the case of the New Zealand Superannuation Fund, this paper argues that the sustainability problem can be significantly reduced with prior investment beliefs in the strategies and with governance that has clear accountability, reporting and decision- making structures.

The Treasury and the Reserve Bank of New Zealand hosted a conference during December 10-11, 2007 on the business cycle, housing and the role of policy. Research presented included investigations of recent shocks to the New Zealand business cycle, including the role of housing and the influence of fiscal policies. Research considering the monetary policy transmission mechanism and the roles that fiscal and prudential policies might play in macroeconomic stabilisation was also discussed. In this article, we summarise the themes and insights from this workshop and suggest areas for future work that will aid policy advice.

In the first of two articles on the transmission mechanism of New Zealand monetary policy, we provide a detailed account of the process by which changes in the Reserve Bank’s primary monetary policy instrument, the Official Cash Rate (OCR), eventually come to influence the general level of prices. As such, the article is a guide to how the Bank perceives policy decisions to propagate through the New Zealand economy, and to the relative weight it assigns to the strengths of the various channels that together comprise the transmission mechanism. A second article, to be published in a forthcoming issue of the Bulletin, considers how this mechanism may have changed over time and how this has influenced the implementation of monetary policy in the most recent business cycle.

The Reserve Bank of New Zealand (RBNZ) is regarded as one of the most transparent central banks in the world. Recent research suggests that one benefit of such transparency is that financial markets better anticipate a central bank's reaction to incoming data and, in relation, do not over-react to macroeconomic data surprises. In this paper, we provide institutional details of how the RBNZ communicates its monetary-policy decisions to financial markets and conduct an events analysis to test whether there are any transparency benefits in the pricing of New Zealand's yield curve. In line with recent empirical literature, our results suggest that short-term interest rates tend to react appropriately to the data flow, while longer-term interest rates are not unduly influenced We also show that market reactions tend to be in line with the RBNZ's inflation-target objective.

Counterfactual experiments with the Reserve Bank of New Zealand's core model provide some insight into the implications for New Zealand's economic performance over the 1990s, had it credibly fixed its currency to the Australian dollar. If New Zealand had faced the relatively more stimulatory Australian monetary conditions prevailing over the 1990s, then output growth may have been temporarily boosted. However, demand pressures would have probably been greater and inflation higher. In particular, results suggest that over the latter part of the 1990s annual inflation would have been approximately 1% point higher on average. Stochastic simulation experiments provide a vehicle to analyse what the implications of currency union might be more generally. Results suggest that if New Zealand were to lose its ability to set monetary policy independent of that set in Australia, then the variability of inflation and output would increase over the business cycle.

This paper is concerned with how stylised differences in monetary policy transmission mechanisms and product and labour market rigidities between the US and euro-area economies affect their resilience to temporary shocks. To address this issue, a small general equilibrium model with long-run neoclassical and short-run neo-Keynesian features is calibrated to replicate the key properties of the US economy (as in the US Fed’s FRB-US model). To this model, features of the euro area’s financial and then product and labour markets are added sequentially with a view to replicating what is generally agreed are aspects of the functioning of the euro-area economy (as captured by the ECB’s Area-Wide Model). Most of the analysis is conducted assuming identical monetary policy reaction functions, although the sensitivity of the results to this assumption is tested. The results illustrate the importance of adjustment patterns in financial, product and labour markets for economies’ ... Les differences, en termes de resilience, entre l'economie americaine et celle de la zone euro Ce document etudie les principales differences en matiere de transmission de la politique monetaire et de rigidites des marches des produits et du travail, et leurs effets sur la resilience des economies des Etats-Unis et de la zone euro aux chocs temporaires. Un petit modele d’equilibre general, de facture neo-classique sur le long terme et neo-keynesienne sur le court terme, est calibre pour reproduire les comportements cles de l’economie americaine (tels que les decrit le modele FRB-US de la Banque de reserve federale des Etats-Unis). Des caracteristiques des marches financiers puis des marches des produits et du travail de la zone euro sont ensuite incorporees dans le modele afin de mieux capter certains aspects du fonctionnement de l’economie de la zone euro (tels que les decrit le modele de la BCE couvrant la zone euro). L’analyse repose largement sur des fonctions de reaction de la politique monetaire identiques, mais l'importance de cette hypothese est testee. Les resultats ...

The New Zealand Treasury and the Reserve Bank of New Zealand both maintain and use comprehensive macroeconomic models of the New Zealand economy: NZM and FPS respectively. In this paper, shocks are applied to the two models to illustrate and compare their dynamic properties. The most notable differences arise from their characterisations of the inflation process. In NZM, inflation is modelled as a cost-push phenomenon, whereas FPS models inflation as a demand pull process. Consequently, shocks arising from demand and cost sources often have quite different implications for monetary policy in the two models. In contrast, in general the long-run responses of the models to permanent shocks are quite similar, although the transition paths differ reflecting both the differing inflation processes and adjustment dynamics.

In this paper, stochastic simulations of the Reserve Bank of New Zealand's new macroeconomic model, FPS, are used to examine the issue of which price index monetary policy should stabilise in a small open economy. Under the class of policy rules considered, targeting a measure of domestic inflation, which does not include the direct effects of exchange rate movements on the price of imported goods, results in lower variability in real output, nominal interest rates, the exchange rate and domestic price inflation. The result is robust if direct exchange rate effects influence agents' expectations of generalised inflation and if the policy maker is uncertain about how direct exchange rate effects influence expectations. Tracing out efficient policy frontiers under the two alternative targets illustrates that for a given level of CPI variability, output variability can be significantly reduced by targeting domestic price inflation.

This paper utilises the partial adjustment approach of Judd and Rudebusch (1998) to empirically estimate the degree of short-term interest rate smoothing by central banks in the dollar block countries. All countries appear to smooth short-term interest rates significantly, with New Zealand and Canada smoothing rates by less than what appears to be the case for Australia and the United States. We then examine the macroeconomic implications of interest rate smoothing using the Reserve Bank of New Zealand's macro model. The model is constructed such that the more interest rates are smoothed in the short-term, the larger inflation and output variability will be over the cycle. However, at least over the narrow range of the empirically based smoothing approaches, the results suggest that there may be little cost in smoothing short-term interest rates in New Zealand to the degree seen in Australia or the United States.

This paper outlines how the Reserve Bank of New Zealand's Forecasting and Policy System (FPS) is used to prepare the quarterly economic projections. In addition to a very brief overview of the system, the paper focuses on four key issues. First, the current methodology for incorporating a time-varying equilibrium path for the economy is presented. Second, the process for building up the central scenario through the application of judgement is outlined. Third, the use of alternative scenarios for testing the implications of key assumptions embodied in the central scenario is discussed. Finally, the technique employed to examine the implications that unforseen shocks have for the projections is discussed.

1 The material presented here draws heavily upon the Bank's internal review of the 1991-1998 business cycle, and papers that have been prepared by the Bank for the Independent Review of the Operation of Monetary Policy in New Zealand, which is being conducted by Professor Lars Svensson at the current time. These papers may be obtained at Any remaining errors and omissions are the sole responsibility of the author.

Simple rules for guiding monetary policy actions have been shown to achieve policy objectives effectively. In many of these simple rules, policy prescriptions depend on the economy's level of potential output. However, potential output is unobservable and is estimated with uncertainty. We examine the effects that this uncertainty has on the stabilisation properties of three classes of simple efficient policy rules. Although the stabilisation properties deteriorate under uncertainty, the deterioration is less pronounced for rules that use forecasts of inflation rather than just contemporaneous inflation. Under the uncertainty considered, the magnitudes of the efficient response coefficients tend to increase.