#1230 1989 · Reserve Bank of New Zealand · Central banking
New Zealand made its central bank governor fireable for missing a target he set himself
the problem
New Zealand had years of high inflation, and government promises to fight it were not credible
background
New Zealand entered the late 1980s with a long history of high, volatile inflation that successive governments had promised, and failed, to bring under control, because interest-rate decisions ultimately sat with elected ministers who faced constant short-term pressure to keep money loose. Every anti-inflation pledge from the Treasury or the central bank carried an implicit asterisk: circumstances, or the next election, could always change the government's mind, and markets priced that risk into wages, contracts, and interest rates for years in advance. Simply appointing a stricter governor or making a stronger public commitment did nothing to remove the underlying problem, since the next government could reverse either one.
What was missing was not resolve but a mechanism that made backing down expensive rather than free. Without some cost attached to abandoning the target, every promise of price stability remained cheap talk that a rational public had learned, through repeated disappointment, not to believe.
what everyone would do
New Zealand could have appointed a governor known for hawkish views, issued a stronger public statement of intent, or passed a non-binding resolution calling for lower inflation — all of which leave discretion, and therefore the option to quietly cave to political pressure, fully intact.
what they saw
New Zealand saw a promise to control inflation was worthless because the government could break it whenever convenient. Letting a governor be fired for missing a public target made the promise cost something to break.
the move
The Reserve Bank of New Zealand Act 1989 gave the Bank legal independence from day-to-day government direction and required the Governor and the Minister of Finance to sign a public Policy Targets Agreement setting a specific inflation range — and the Governor could be formally held accountable, including dismissal, for failing to deliver it.
why it works
Markets don't price in what a government says it will do, they price in what it's structurally forced to do, because talk is free and structure isn't. By writing a numeric target into a public agreement tied to one person's job, the Act converted an abstract political intention into a concrete, monitorable, personally costly commitment — the Governor now had every incentive to hold the line that ministers previously lacked. Because the target and the accountability were both public, anyone could verify in real time whether the commitment was being honored, which is what let inflation expectations fall before a single interest-rate decision was even made.
the payoff
New Zealand became the first formal inflation-targeter; inflation fell into single digits, and other central banks later copied the model.
where it breaks
The mechanism only works if the target itself is achievable and if the government resists the temptation to simply rewrite the Policy Targets Agreement whenever the current target becomes inconvenient — the credibility comes from the target being hard to change, not merely written down. It also concentrates enormous pressure on a single official, which can produce overly rigid policy in genuine crises the target wasn't designed for.
what came after
Formal inflation targeting, pioneered by this Act, was subsequently adopted by Canada, the United Kingdom, Sweden, and dozens of other central banks as the standard framework for monetary policy credibility.
references
- [1]History of the Remit and policy targets agreementReserve Bank of New Zealand — Te Pūtea Matua, 2021rbnz.govt.nz
- [2]Thirty years of inflation targeting in New ZealandVictoria University of Wellington, 2018wgtn.ac.nz