Real effects of monetary policy in New Zealand

Abstract

This paper analyzes the dynamic effects of unexpected domestic and foreign monetary policy shocks on 'industrial output' in New Zealand based on a 'new open economy macroeconomic' (NOEM) model. Empirical analyses are performed using unrestricted recursive open economy Vector Autoregressive (VAR) models involving policy and non-policy variables of New Zealand and four of its most important trading partners, i.e. Australia, Japan, United Kingdom and USA. The empirical findings are in accord with the qualitative predictions of monetary transmission channels relevant to a small open economy and no empirical anomalies are observed regarding the NZ output behaviour following a domestic restrictive monetary policy shock. Besides, the empirical findings also indicate that the full effects of a restrictive domestic monetary policy shock on industrial output in New Zealand are faster when Australian and US variables are included in the VAR model of monetary transmission compared to the cases when Japanese and UK variables are incorporated into the same model. On the other hand, domestic industrial output shows contraction due to a restrictive foreign monetary policy shock; reflecting the small open economy feature of New Zealand.