# The mouse that roared: New Zealand and the world’s 2% inflation target
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2023-01-30
Category: NEWS
Category URL: https://financedigest.com/category/news
Meta Title: From 2% to Zero: The Evolution of Inflation Targeting in New
Meta Description: Explore the origins of inflation targeting in New Zealand and its impact on global central banking practices. Learn how this policy has shaped the economy and
URL: https://financedigest.com/the-mouse-that-roared-new-zealand-and-the-worlds-2-inflation-targethtml

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By Lucy Craymer

WELLINGTON, New Zealand (Reuters) – More than 30 years ago, some relatively youthful central bank and Treasury economists in New Zealand were grappling with how to bring two decades of double-digit inflation under control in an economy less than 1% the size of its U.S. counterpart.

What if, they asked, they just told everyone the [rate should be much lower – say](https://www.financedigest.com/bank-of-england-raises-rates-to-3-5-says-inflation-has-peaked.html "Bank of England raises rates to 3.5%, says inflation has peaked") roughly 2% – and then aim for that?

It was a bit of a shock to everyone, I think,” said Roger Douglas, the Labour Party [finance minister](https://www.financedigest.com/scottish-finance-minister-kate-forbes-to-run-for-countrys-leadership.html "Scottish finance minister Kate Forbes to run for country’s leadership") at the time who worked with the Treasury and Reserve Bank of New Zealand (RBNZ) to pioneer the policy. “I just announced it was gonna be 2%, and it sort of stuck.”

Like that, [inflation targeting](https://www.financedigest.com/euro-zone-inflation-seen-just-above-ecbs-target-in-2025-poll-shows.html "Euro zone inflation seen just above ECB’s target in 2025, poll shows") was born.

Since it’s arrival in 1990, the 2% inflation target phenomenon has sailed from Wellington around the globe to become the accepted norm among central banks, large and small, for grounding public [expectations for what inflation](https://www.financedigest.com/dollar-drops-as-inflation-cools-more-than-expected.html "Dollar drops as inflation cools more than expected") ought to be. But the price spikes spawned by the COVID-19 pandemic are set to test their devotion to it in the [months ahead as inflation looks set to remain](https://www.financedigest.com/6-months-to-go-until-brexit-and-investor-sentiment-remains-bold.html "6 months to go until Brexit and investor sentiment remains bold") stubbornly above 2% for some time.

As some observers question whether that level remains valid today – in most cases debating if it should be raised to blunt the blows to growth and employment from the high interest [rates being employed by central banks](https://www.financedigest.com/bank-of-englands-mann-doubles-down-on-backing-for-rate-hikes.html "Bank of England’s Mann doubles down on backing for rate hikes") in order to achieve it – the inflation-targeting pioneers in New Zealand are standing by it.

In fact, Arthur Grimes, a [former chief economist and senior official](https://www.financedigest.com/italy-names-former-treasury-official-to-head-ita-airways.html "Italy names former Treasury official to head ITA Airways") at the RBNZ who was seen as one of the key architects of the policy, would like the target to include a lower range.

Zero’s the obvious sort of place to head for – it is basically saying, on average, prices in 10 [years](https://www.financedigest.com/hong-kong-home-prices-drop-15-6-in-2022-snap-13-years-of-gain.html "Hong Kong home prices drop 15.6% in 2022, snap 13 years of gain") time should be roughly the same as prices now. Why would you want anything different?” he said.

![](https://www.globalbankingandfinance.com/wp-content/uploads/2023/01/chart-2.jpg)

‘MOST DESPISED MAN’

When New Zealand became the first country to mandate [inflation targeting](https://www.financedigest.com/japans-inflation-stays-above-bojs-target-key-gauge-hits-four-decade-high.html "Japan’s inflation stays above BOJ’s target, key gauge hits four-decade high"), the upper limit was 2% and the lower one just 0%. At the time, [inflation was running at 7.6% but had tracked above 10% on average](https://www.financedigest.com/average-annual-uk-food-bill-set-to-rise-454-pounds-as-inflation-soars.html "Average annual UK food bill set to rise 454 pounds as inflation soars") between 1970 and 1990, and few people thought the target was realistic.

There “were some pretty vicious internal debates, not everyone I think was particularly convinced that we should be aiming for something as low we were,” said Michael Reddell, a former RBNZ economist, who at the time headed the economics department’s [monetary policy](https://www.financedigest.com/uks-ftse-100-dips-on-scope-of-tighter-monetary-policy-informa-jumps.html "UK’s FTSE 100 dips on scope of tighter monetary policy; Informa jumps") section.

“It wasn’t the most scientific process in the entire world … we had limited resource. Nobody had done this before us,” he added.

The adoption of the [inflation target was followed by aggressive](https://www.financedigest.com/stocks-tumble-dollar-rallies-as-soaring-u-s-inflation-implies-an-aggressive-fed.html "Stocks tumble, dollar rallies as soaring U.S. inflation implies an aggressive Fed") monetary tightening, with 90-day rates climbing to 15% in 1990. A year later, [inflation had fallen to 2% and New Zealanders’ inflation expectations](https://www.financedigest.com/ecb-survey-shows-rising-inflation-expectations-despite-energy-price-falls.html "ECB survey shows rising inflation expectations despite energy price falls") adjusted quickly to the new paradigm.

But there were severe short-term costs for businesses and workers, with the economy stagnating between 1989 and 1994 and the unemployment [rate rising](https://www.financedigest.com/uk-inflation-rate-unexpectedly-rises-to-10-4-in-february.html "UK inflation rate unexpectedly rises to 10.4% in February") into double-digit figures.

[Since that time](https://www.financedigest.com/soccer-arsenal-reach-womens-champions-league-semis-for-first-time-since-2013.html "Soccer-Arsenal reach Women’s Champions League semis for first time since 2013"), the target has been shifted twice, initially to a range of 0% to 3% and then in 2002 to the 1%-3% range.

The [decision – and the resulting policy](https://www.financedigest.com/asian-shares-rise-dollar-dips-ahead-of-fed-policy-decision.html "Asian shares rise, dollar dips ahead of Fed policy decision") – was driven largely by politics.

[Governments had engaged in spending sprees to win votes at the expense of inflation](https://www.financedigest.com/factbox-how-governments-are-trying-to-ease-inflation-pain.html "Factbox-How governments are trying to ease inflation pain"). Douglas, the former finance minister, asked the central [bank and Treasury to pioneer the policy](https://www.financedigest.com/what-to-make-of-the-headlines-brexit-and-bank-of-england-policy-eba-bank-stress-tests.html "What to make of the headlines? Brexit and Bank of England policy, EBA bank stress tests") to prevent that from happening again.

Initially there was debate about whether [interest rates](https://www.financedigest.com/ecbs-centeno-says-interest-rate-close-to-peaking-if-no-new-shocks.html "ECB’s Centeno says interest rate close to peaking if no new shocks") or money supply should be the target, but it was decided it was better to target the ultimate goal: inflation.

They did all the [hard work](https://www.financedigest.com/meet-the-women-working-hard-in-house-building.html "Meet The Women Working Hard In House Building") and I just got all the glory and the title of being the most despised man in New Zealand,” Douglas said.

IN THE SPOTLIGHT

But to New Zealanders used to high inflation, a 2% [rate seemed](https://www.financedigest.com/stocks-dip-yields-climb-as-rate-hikes-seem-to-stay-the-course.html "Stocks dip, yields climb as rate hikes seem to stay the course") unbelievable. Don Brash, then the RBNZ governor and later the leader of the opposition National Party, said he [held grueling meetings](https://www.financedigest.com/emvcos-2017-emv-user-meeting-to-be-held-in-vietnam.html "EMVCo’s 2017 EMV User Meeting to be Held in Vietnam") with everyone from news organizations to grassroots bodies to get them on board.

New Zealand faced rising unemployment, with [wages failing to keep up with the cost of living](https://www.financedigest.com/pensions-awareness-day-could-you-get-by-on-less-than-living-wage.html "Pensions Awareness Day: Could you get by on less than living wage? "). Reuters reported in 1994 that 13 protesters were dragged from the foyer of the RBNZ in Wellington and arrested after demanding the central bank let [inflation rise](https://www.financedigest.com/oil-rises-about-2-with-u-s-and-china-inflation-in-focus.html "Oil rises about 2% with U.S. and China inflation in focus").

The conclusion from our history about that, is that if you don’t want to damage the real [economy don’t let inflation get away](https://www.financedigest.com/global-economy-collapse-just-one-click-away.html "Global economy collapse just one click away") in the first place. Because the path [back to low inflation](https://www.financedigest.com/love-in-a-time-of-inflation-how-much-will-valentines-day-set-you-back.html "Love in a time of inflation: how much will Valentine’s Day set you back?"), from embedded inflation always involves output losses,” said Graham Scott, who was the secretary of the Treasury from 1986 to 1993.

After the changes were introduced, New Zealand found itself under a spotlight. It attracted better economic event speakers, and the architects of the [policy were invited to major gatherings including](https://www.financedigest.com/ing-toughens-oil-and-gas-policy-to-include-trade-finance-midstream.html "ING toughens oil and gas policy to include trade finance, midstream") the U.S. Federal Reserve’s annual symposium in Jackson Hole, Wyoming. Other [central bankers](https://www.financedigest.com/inflation-fighting-central-bankers-air-climate-role-doubts.html "Inflation fighting central bankers air climate role doubts") were keen to understand what had happened.

“‘How did we do it?’ became the bigger question than ‘what we did,” Douglas said. I mean, most people didn’t [really argue with what we were doing but they wondered how the heck we managed](https://www.financedigest.com/with-the-right-active-manager-you-really-do-get-what-you-pay-for.html "With the Right Active Manager, You Really Do Get What You Pay For") to get away with it.

(Reporting by Lucy Craymer; Editing by Dan Burns and Paul Simao)


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