New Zealand’s economy shrank 0.9 per cent in the June quarter. A chorus of commentators, politicians and economists are blaming the Reserve Bank for this poor performance. They claim the RBNZ choked the economy with interest rates that were too high for too long. 

To be clear, the RBNZ’s mistakes during Covid caused the inflation spike in the first place. But that does not make it right to criticize the RBNZ for correcting its past mistakes. 

The Reserve Bank has one core job, assigned to it by the government – to keep inflation within a 1 to 3 per cent band. So, when inflation rocketed to 7.3 per cent in June 2022, the Bank faced a genuine crisis. 

More dangerously, surveys showed that people and businesses expected inflation to remain high, risking a return to the wage-price spirals of the 1970s. 

While the Bank’s pandemic-related money printing contributed to the loss in price stability, once inflation had taken hold, it had no choice but to act forcefully. Its strong medicine worked, and inflation is now back under control. It did exactly what its contract with the government required it to do. 

The real story since the pandemic is not of monetary policy error but of policy misalignment. The Bank was battling inflation while the government pushed its foot on the fiscal accelerator. 

Budgets in 2022, 2023 and 2024 pumped more spending power into the economy at precisely the wrong time. Budget 2024’s $3.7 billion in annual tax cuts are but one example. 

The International Monetary Fund explicitly warned against this decision, highlighting New Zealand’s structural deficit of 2.8 per cent of GDP – among the largest in advanced economies. The tax cuts worked directly against the Bank’s efforts to curb inflation. 

With the government overstimulating the economy, the Reserve Bank had no choice but to keep interest rates higher for longer than would otherwise have been necessary.  

The two arms of policy working at cross-purposes was not helpful for bringing inflation under control. In fact, it made the RBNZ’s job harder.  

Blaming the Bank for doing its job is a regrettable exercise in blame-shifting. 

The government must prioritise developing a credible plan for fiscal consolidation that reduces ill-justified spending and brings debt back to a prudent level. Monetary policy needs a partner in government, not a critic working against it. 

The question is not why the RBNZ held rates so high, but why it was forced to.  

New Zealand’s growth potential will remain constrained until its fiscal and monetary authorities stop pulling in opposite directions. 

Read our latest research note “Monetary Policy Without Mates: Why the Reserve Bank is Right to Focus on Price Stability” here.