The impact of the crisis onMonetary policy

Credit Suisse Asian Investment Conference

Hong Kong25 March 2010

Grant Spencer Reserve Bank of New Zealand

Impact of the Crisis on Monetary Policy

• Pre-crisis monetary policy

• Post-crisis monetary policy

• Role of prudential policy

The pre-crisis experience

• NZ monetary policy tighter than overseas

• Domestic impact reduced by inverse yield curve

• Pressure on exchange rate through carry trade

NZ borrowers took advantage of inverse yield curve

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

90 day 1y 2y 3y 4y 5y 7y 10y

US

NZ

Percent As at March 2007

NZD pressured by carry trade

Foreign holdings of NZD securities grew rapidly pre-crisis

0

10

20

30

40

50

60

70

80

Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09

Eurokiwi Bonds

Uridashi Bonds

Corporate Debt (Bonds and CP)

Kauris

Govt Securities

NZD (Billions) Breakdown of net outstanding NZ dollar fixed income securities held offshore

Financial Crisis

Impact of the Crisis on Monetary Policy

• Pre-crisis monetary policy

• Post-crisis monetary policy

• Role of prudential policy

Post-crisis expectation

• Price stability still the appropriate target

• Monetary policy to have more kick

• Likely to be reinforced by Prudential policy

“Flexible inflation targeting” passed the oil shock test in 2008

0

1

2

3

4

5

6

Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-090

1

2

3

4

5

6

7

8

9

Annual CPI inflation Official Cash Rate (RHS)

Annual % %

Policy Target Band

Monetary policy impact will be enhanced

• Higher bank cost of funds

• Reduced asset price expectations

• Positive yield curve

Bank funding costs up 120-130bp

2

3

4

5

6

7

8

9

Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10

'Extra' deposit costs (55%)

Long-term wholesale (15%)

Short-term wholesale (30%)

OCR

Indicative marginal funding costs relative to the OCR

Note: Weights assume banks are raising funds in proportion tothe existing structure of their liabilities. The compositionof funding at any particular time will vary from these weights.

Cost of funds 20-30 bps over OCR

Cost of funds 150 bps

over OCR

Percent

Pushing up lending margins over OCR

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Pre-crisis (Aug 07) Post-crisis (Jan 10)

Floating rate - OCR

2yr mortgage rate - 2yr swap rate

Percent

Demand side factors have also reduced the “neutral” OCR level

• Lower house price inflation

• Reduced debt appetite

• Tax measures mooted on housing

NZ yield curve now positive

(borrowers have nowhere to hide)

2

3

4

5

6

7

8

90 day 180 day 1yr 2yr 3yr 4yr 5yr 7yr 10yr

Bank bill rates Swap rates

Percent

March 2007

Current

Impact of the Crisis on Monetary Policy

• Pre-crisis monetary policy

• Post-crisis monetary policy

• Role of prudential policy

Monetary policy to be reinforced by prudential

• New prudential liquidity policy a stabilising force

• RB exploring other macro-prudential options

• Caution warranted on macro-prudential

New prudential liquidity policy

Liquid assets Stable funding

• One week mismatch ratio to be met by primary liquids

• One month mismatch ratio to be met by primary and secondary liquids

• Secondary liquids include bank paper up to specified limits

• Core funding ratio: at least 65%, moving up to 75% by mid 2012

• Core funding = customer funding (weighted by deposit size) plus market funding > 1 year to maturity

(starts 1 April 2010)

Core funding ratio has been cyclical

Core funding ratio(% of loans and advances)

A cautious approach to macro-prudential

• Few realistic options for active management

• Need to keep prime purpose clear: Financial system stability

• Potential to reinforce monetary policy on up-cycle (asymmetric)

• Potential efficiency costs if pursued too aggressively

End of presentation