Reserve Bank held rates too low during pandemic, driving record inflation, review finds

New Zealand's Reserve Bank made a consequential error in the years following the pandemic's onset, according to a review released this afternoon. The central bank held interest rates at historic lows for longer than economic conditions warranted, allowing the economy to overheat to what the reviewers called "an historically extreme degree." The result was inflation that climbed to 7.3 percent—well above the bank's target—and a boom-bust cycle whose effects the country continues to absorb.

The review, conducted by former Reserve Bank assistant governor David Archer and MIT professor Athanasios Orphanides, examined the bank's decision-making between 2020 and 2021. In March 2020, as the pandemic struck, the bank cut the official cash rate to 0.25 percent and began purchasing billions in government bonds to inject money into a contracting economy. The reviewers praised this initial response as timely and necessary. But what followed was a failure of adjustment. The economy recovered faster than almost anyone had anticipated, yet monetary policy remained loose. "It took a full year for policy to adjust to the reality that the initial economic stimulus had already achieved the intended result," Archer and Orphanides wrote. "Unexpectedly positive incoming data were discounted, and upside risks to the inflation outlook downplayed."

By the time the bank began raising rates, the damage was already embedded in the economy. Unemployment fell to 3.2 percent, which the review identified as unsustainably low. Inflation, meanwhile, had accelerated well beyond what the bank's mandate required it to control. Finance Minister Nicola Willis, who commissioned the review, characterized the bank's error plainly: it was "too slow to take its foot off the accelerator."

The review identified multiple structural and policy factors that contributed to the mistake. A law change by the previous government had expanded the Reserve Bank's mandate to include supporting maximum sustainable employment alongside controlling inflation. The reviewers found this dual mandate "downplayed the importance of price stability" in the bank's deliberations. But the mandate was only one of several problems. Before the pandemic, the bank had curtailed its own scenario analysis and built a monetary policy committee that prioritized consensus over what the reviewers called "diversity of thought." This institutional structure made the committee less likely to challenge prevailing assumptions or surface dissenting views.

Another subtle but consequential error involved how the bank communicated its own tightening. Even as officials publicly announced they were withdrawing stimulus and raising rates, the real interest rate—the official cash rate minus inflation—continued to decline and reached historic lows. This gap between the stated policy and its actual effect on borrowing costs was "rarely discussed" in the committee's communications, the review found. Borrowers and savers were responding to the real rate, not the nominal one, meaning the bank's loosening effect persisted long after it claimed to be tightening.

The reviewers modeled three alternative scenarios for how policy could have unfolded differently. One path—beginning to raise rates earlier but moving gradually—would have contained inflation below 5 percent and eliminated the boom-bust cycle entirely. This scenario would also have better served both of the bank's mandates, keeping unemployment closer to sustainable levels while maintaining price stability. "Had the monetary policy committee implemented policy as in scenario three, it would have fulfilled its dual mandate considerably better," the reviewers concluded.

Willis responded to the review by pointing to the government's decision to restore the Reserve Bank's single focus on inflation control, reversing the previous government's dual mandate. She also highlighted recent changes to the monetary policy committee's charter designed to encourage diversity of thought, including making individual members' votes public when consensus breaks down. But Willis stopped short of committing to other recommendations in the review, saying the government would "consider further advice" on the interaction between financial governance and monetary policy.

The review's release came 46 days before a general election and days before Parliament rose for the campaign, prompting critics to question the timing. Willis had pushed for an independent review while in opposition, after the previous Labour government reappointed Reserve Bank governor Adrian Orr in 2022. The review itself offers no judgment on whether the bank's errors were inevitable or avoidable, only that they happened—and that the country is still living with the consequences.