Lag in effect of tight money policy

Press, 18 December 1985, Page 38

Lag in effect of tight money policy

PA Wellington Introduction of a tighter monetary policy can be effective in reducing the rate of inflation but there will be a lag before the effect is apparent, according to an article in the latest “Reserve Bank Bulletin.”

Based on an analysis by the bank, the article looks at four economies, those of the United Kingdom, United States, Canada and Australia.

The Australian economy was not analysed in detail because the introduction of a tighter monetary policy in that country was too recent for the effects to be felt fully. The analysis for the other three countries showed that the lag between a tightening in monetary policy, and the fall in inflation varied considerably. In the United States, inflation began falling within

a year after the imposition of a firm monetary policy and after three years had dropped from its peak of 14 per cent, to below 5 per cent.

In Canada, inflation peaked at 12 per cent 2-1/2 S after the policy was uced and had fallen to 5 per cent after 4-1/2 years. However, the path followed by prices was influenced also by high wage growth and devaluation of the Canadian dollar. After three years of a similar policy, inflation in the. United Kingdom had fallen to 5 per cent. The article says this experience suggests that a tightening of monetary policy will reduce real growth in the main monetary aggregates, but with a potentially significant lag. “The overseas experience also suggests that a sustainable reduction in the inflation rate is obtainable over the medium term with a firm monetary policy,” it says. “However, wage rates and the exchange rate are also important determinants of inflation in the shortterm. Higher wage settlements, for example, will tend to slow the rate at

which the inflation rate falls.

“Finally, the high interest rates currently being experienced in New Zealand have also been associated with tight monetary policies in the United States, the United Kingdom, Canada and Australia.

“The experiences of these countries suggest that nominal interest rates are likely to fall as inflation is reduced; however, real interest rates are unlikely to fall below world levels which remain high by historical standards.”