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.

This is the second of two Bulletin articles on the transmission mechanism of New Zealand monetary policy. In the first article (Drew and Sethi 2007), we described this mechanism, detailing the process by which changes in the Reserve Bank’s primary monetary policy instrument, the Official Cash Rate (OCR), eventually influence the general level of prices. This article examines how certain aspects of the transmission mechanism have changed over time. Assessing these changes is especially topical given that, in the estimation of some commentators, the most recent period of monetary tightening has witnessed policy that has been less effective at dampening inflation than previously. We briefly review the case for these claims and catalogue evidence from several sources to show that the overall impact of monetary policy on activity and inflation has not obviously weakened, and that some intermediate links in the mechanism may have, in fact, strengthened over the past decade.

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.

Computing the optimal trajectory over time of key variables is a standard exercise in decision-making and the analysis of many dynamic systems. In practice however, it is often enough to ensure that these variables evolve within certain bounds. In this paper we study the problem of setting monetary policy in a ‘good enough’ sense, rather than in the optimising sense more common in the literature. Important advantages of our satisficing approach over policy optimisation include greater robustness to model, parameter, and shock uncertainty, and a better characterisation of imprecisely defined monetary policy goals. Also, optimisation may be unsuitable for determining prescriptive policy in that it suggests a unique ‘best’ solution while many solutions may be satisficing. Our analysis frames the monetary policy problem in the context of viability theory which rigorously captures the notion of satisficing. We estimate a simple closed economy model on New Zealand data and use viability theory to discuss how inflation, output, and interest rate may be maintained within some acceptable bounds. We derive monetary policy rules that achieve such an outcome endogenously. ∗ The views expressed in this paper are those of the author(s) and do not necessarily reflect the views of the Reserve Bank of New Zealand. We thank Larry Christiano, Andrew Coleman, Seppo Honkapohja, Christie Smith and seminar participants at the Reserve Bank of New Zealand for helpful discussion. We also thank Kunhong Kim for advice and acknowledge earlier work on this topic with Krawczyk. All errors are our own. † School of Economics and Finance, Victoria University of Wellington. Email: jacek.krawczyk@vuw.ac.nz. Economics Department, Reserve Bank of New Zealand, 2 The Terrace, Wellington, 6011, New Zealand. Tel: +64 4 471 3810, Fax: +64 4 473 1209. Email: rishab.sethi@rbnz.govt.nz ISSN 1177-7567 ©Reserve Bank of New Zealand

In this paper we use a small open economy model to identify the causal factors that drive New Zealand's current account. The model features nonseparable preferences, habit in consumption, imperfect capital mobility, permanent productivity shocks, fiscal shocks and two foreign shocks to explore features that are important in understanding the dynamics of the current account. The results suggest that permanent technology shocks and world cost of capital shocks account for the bulk of variation in the current account at short horizons; at longer horizons, external valuation shocks (reflecting terms of trade and exchange rate developments) account for most of the variance. Habit in consumption and a debt-sensitive risk premium are features that improve overall model it as measured by posterior odds ratios. These features, and the contribution of foreign and permanent technology shocks, help to explain why the one shock present value model of the current account fails to appropriately characterise the dynamics of the New Zealand current account, as discussed in Munro and Sethi (2006).

Computing the optimal trajectory over time of key economic variables is a standard exercise in the analysis of many macroeconomic systems. In practice, however, it is may be enough to ensure that these variables evolve within certain bounds rather than optimally. In this paper we study the problem of setting monetary policy in a “good enough” or satisficing sense, rather than in the optimising sense more common in the literature. Important advantages of our approach over policy optimisation include greater robustness to model, parameter, and shock uncertainty, and an adequate characterisation of otherwise imprecisely defined monetary policy goals. Our analysis frames the monetary policy problem in the context of mathematical viability theory, which rigorously captures the notion of satisficing. A solution to a viability problem is a set of initial conditions for the system, for which there exist strategies that maintain the system within a desired state domain. We estimate a simple small open economy model on New Zealand data and use viability theory to discuss the possibility of maintaining inflation, output, and interest rate within some acceptable bounds. We derive interest rate rules that achieve such an outcome endogenously.