According to an independent review released by the New Zealand government, the Reserve Bank kept interest rates at record lows for too long during the Covid-19 pandemic, driving inflation to record highs and triggering a boom-bust cycle. The economy overheated to a historically extreme degree, according to the findings authored by former Reserve Bank assistant governor David Archer and Massachusetts Institute of Technology professor Athanasios Orphanides.
How the Reserve Bank’s Pandemic Stimulus Overheated the Economy
The Reserve Bank’s initial emergency response to the Covid-19 pandemic was praiseworthy and timely, according to the review by David Archer and Athanasios Orphanides. In 2020, the central bank cut the official cash rate to 0.25 percent and began buying billions of dollars in government bonds through Large Scale Asset Purchases, or LSAPs, alongside a funding for lending programme.
However, the review found that the monetary stimulus remained in place for far too long as the economy rebounded faster than expected. It took a full year for policy to adjust to the reality that the initial economic stimulus had already achieved its purpose. Positive incoming data was discounted, and upside risks to inflation were downplayed by the monetary policy committee.
Did you know? During the height of the post-lockdown recovery, New Zealand’s unemployment rate fell to 3.2 percent—labeled an “unsustainable historic low” by reviewers—while inflation peaked at 7.3 percent, well above the central bank’s target band.
The Dual Mandate and Real Interest Rate Pitfalls
Finance Minister Nicola Willis, who commissioned the report, stated that the findings showed the central bank was “too slow to take its foot off the accelerator” between 2020 and 2021. Willis singled out the previous government’s decision to broaden the bank’s mandate to include supporting maximum sustainable employment. According to the review, this dual mandate helped steer decision-makers away from strict price stability by downplaying the importance of inflation control.
The review also highlighted a critical communication and policy gap: the real interest rate—calculated as the official cash rate minus inflation—actually declined and reached historic lows even after the bank publicly communicated that it was withdrawing stimulus and raising nominal rates. According to the reviewers, this real rate was rarely discussed in the monetary policy committee’s communications, allowing monetary policy to remain effectively loose while the nominal rate was rising.
Alternative Paths and Policy Recommendations
Modelling in the report evaluated three alternative policy paths. Reviewers found that starting to lift the official cash rate earlier and moving gently—identified as scenario 3—would have kept inflation below 5 percent and avoided the subsequent boom-bust cycle entirely. The reviewers noted that this path would have fulfilled the bank’s dual mandate considerably better by containing inflation while keeping unemployment closer to its maximum sustainable level.
The independent report outlined several recommendations for the Reserve Bank moving forward. Reviewers urged the central bank to develop a framework for making better decisions under uncertainty, test a wider range of scenarios, and use simple benchmarks to check policy decisions. Additionally, the report noted that New Zealand was not ready to use the full range of tools when the official cash rate approached its lowest practical limit, pointing out that a negative interest rate policy was inexplicably not ready for implementation.
Frequently Asked Questions
What caused New Zealand’s high inflation following the pandemic?
According to the independent review by David Archer and Athanasios Orphanides, high inflation was driven by the Reserve Bank keeping interest rates at record lows too long and maintaining monetary stimulus long after the economy had already recovered from the initial shocks of the Covid-19 pandemic.
What was the dual mandate’s role in the Reserve Bank’s decisions?
The review found that a law change by the previous government giving the bank a dual mandate to support maximum sustainable employment alongside controlling inflation helped steer decision-makers away from prioritizing price stability.
How high did inflation and employment reach during this period?
Inflation peaked at 7.3 percent, which was well above the target, while the unemployment rate dropped to an unsustainable historic low of 3.2 percent.
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