It’s The OCR That Matters For Inflation Targeting

The Reserve Bank of New Zealand – Te Pūtea Matua – is well placed to manage the wind-down of additional monetary policy (AMP) tools, Assistant Governor Karen Silk says in a speech today to the KangaNews New Zealand Debt Capital Markets Summit 2022.

The Reserve Bank made changes to its monetary policy implementation framework during the COVID-19 pandemic. The Reserve Bank’s monetary policy implementation framework sets out how the supply of settlement cash is managed to ensure short-term interest rates trade around the Official Cash Rate (OCR). This ensures that monetary policy transmits through the economy. The purpose of supplying settlement cash is to enable commercial banks to settle all the payments that occur in the economy, each day.

The changes to the framework in 2020 mean that the current high level of settlement cash does not undermine the stance of monetary policy, as all balances are remunerated at the OCR. The changes also mean that the Reserve Bank is well placed to manage the evolution of the balance sheet over the coming years.

“Changes to the settlement cash level are not meaningful for the stance of monetary policy, so long as the level is sufficient for payment and settlement needs and balances are remunerated at the Official Cash Rate (OCR),” Karen Silk says.

The stance of monetary policy is primarily determined by the level of the OCR, which is set by the Monetary Policy Committee. The OCR level is based on the assessment and forecast of economic conditions. It is the OCR that matters for inflation targeting.

“It is important to understand that the level of settlement cash does not create inflation or deflation; in fact, in New Zealand, we have experienced periods of large settlement cash growth before, without changes to the stance of monetary policy,” she says.

The Reserve Bank will continue to supply sufficient settlement cash so that payments and settlements function smoothly. As settlement cash declines, staff will monitor market conditions and consider the optimal mix of tools and operations to ensure that short-term interest rates remain anchored around the OCR.

More information:

• Speech: New Zealand’s Monetary Policy Implementation Framework

What is settlement cash?

The Reserve Bank is the banker to the commercial banks in New Zealand. Banks hold accounts with the Reserve Bank in the Exchange Settlement Account System (ESAS).

In ESAS, banks settle transactions between each other – on behalf of customers – throughout the day. Settlement cash is what is used for these payments and settlements. Settlement cash can only move between banks who have an ESAS account, the Crown, and the Reserve Bank.

The total amount of account balances held within this system is called the settlement cash level (SCL). While banks can raise or lower their own ESAS account balances, and transactions from the Crown can withdraw and inject settlement cash, the total amount of settlement cash in ESAS and the Crown account is determined by the Reserve Bank.

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