Policy framework seen as best fit despite low inflation

"The phenomenon of low inflation is one that most of the industrialised world is experiencing." Gabriel Makhlouf, Treasury secretary. Photo / Doug Sherring

Treasury secretary Gabriel Makhlouf says he's seen no evidence that the policy framework between the Reserve Bank and the Finance Minister needs to be "radically different" despite weak inflation, and the department's regular review of the policy targets agreement (PTA) will be "business as usual".

The PTA requires monetary policy to hold inflation between 1-to-3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent midpoint.

Inflation barely registered at a 0.1 per cent annual rate in the final three months of 2015 and has now been below the target band since September 2014.

That's prompted speculation that the agreement may need tweaking when it comes up for review at the end of governor Graeme Wheeler's five-year term in September 2017. "The phenomenon of low inflation is one that most of the industrialised world is experiencing," Makhlouf said.

"We have seen no evidence in the Treasury that's led us to conclude we would need a different framework. We always review the policy targets agreement, and that's a process we are going to go through in the next 12 to 15 months but it's business as usual, as opposed to a special project.

"It will involve as much care as we have always done and if we conclude we need to change something that's what we'll do but I'm not sitting here thinking we're going to have something radically different in the future."

Makhlouf said Treasury's review will "almost certainly" look at the experience of other countries with different systems, although he noted there was no obvious alternative.

"There's no system out there today that's clearly producing something that an objective analysis would say is better than that system," he said.

The Reserve Bank, which cut interest rates to a record low 2.25 per cent this month, has indicated it will lower the benchmark further if expectations for future inflation continue to fall.

Its survey published last month showed expectations for inflation two years out fell to 1.63 per cent, the lowest since 1994, while an ANZ Bank survey showed inflation expectations at a record low 1.39 per cent. A

NZ is due to release its latest survey of expectations today, and Bank of New Zealand expects the rate to fall, tracking declines in headline inflation.

Finance Minister Bill English has said he's prepared to wait for the scheduled review of the PTA next year to consider whether it's still appropriate, but noted he hadn't seen any compelling intellectual argument that the agreement itself could change or any particularly coherent alternative proposal.

Makhlouf said the current inflation environment wouldn't necessarily persist over the medium term, given the shake-up in the oil sector was unlikely to be repeated in the near term.

While low inflation was beneficial for those who wanted to borrow money to invest in good ideas, it wasn't favourable to those seeking returns on their cash savings, he said.

Returning inflation to the middle of the band over the medium term was important, he said.

"If you get locked into a cycle of expecting lower and lower inflation, there are bigger economic risks as people start to postpone decisions and that then slows down economic activity, so it does matter."