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Reserve Bank

by John Singleton

The Reserve Bank has a number of levers to pull to manipulate the New Zealand economy. It can pressure banks’ interest rates and intervene in the foreign exchange market to keep the economy healthy. Since 1989 the bank’s mandate has shifted from ensuring full employment to restraining inflation.

Origins and functions

What is a Reserve Bank?

Central, or reserve, banks are not-for-profit public policy agencies that stand between governments and banks. They issue bank notes and provide banking services to the government and commercial banks. Reserve banks have oversight of the banking system and may act as an emergency lender of last resort. They are a primary source of bank reserves, and have the ability to influence monetary conditions and spending in the economy by operating in financial markets or through regulation. By controlling the supply of money in the economy they can influence both interest rates and inflation.

Before the Reserve Bank

Before the creation of the Reserve Bank each trading bank in New Zealand issued its own bank notes. Most of the banks also operated in Australia. They held the bulk of their reserves in British pounds and British government securities in London.

During the late 1920s and early 1930s the financial situation in Australia was much worse than it was in New Zealand. Trading banks in New Zealand (four out of six of which were Australian-owned) were also losing reserves because of the Australian crisis – basically the Australian banks were running out of money. Since banks’ New Zealand and Australian reserves were indistinguishable, their capacity to sustain business in New Zealand was reduced.

Dragging at Australia’s coat-tails?

In 1932 Montagu Norman, governor of the Bank of England, had discussions with William Downie Stewart, the New Zealand minister of finance. According to Norman’s notes, he ‘suggested that the first and most important thing for New Zealand was to determine their attitude as an economic unit: were they to be dragged at the tail of Australia or to face their own affairs: in short, did his Government intend to form a Central Bank?’1

Forming the Reserve Bank

Sir Otto Niemeyer, a senior official of the Bank of England, went to Australia in 1930 to discuss the financial crisis with the Australian government. The New Zealand government took this opportunity to ask Niemeyer to advise New Zealand on exchange-rate policy. The Bank of England’s policy was to promote central banking in other parts of the world, and Niemeyer recommended the establishment of a central bank in New Zealand. By encouraging the spread of central banking, the Bank of England hoped to bolster the financial network based in London, to ensure that other governments serviced and repaid their sterling debts, and to deter the adoption of unconventional monetary policies.

First governor of the Reserve Bank

Leslie Lefeaux, the first governor of the Reserve Bank, was a stuffy Englishman who had been deputy chief cashier and assistant to the governors at the Bank of England. He did not adapt well to life in Wellington. When Labour achieved power in 1935, with plans to take the Reserve Bank into full state ownership, Lefeaux was outraged and considered resigning. But his former colleagues at the Bank of England persuaded him to remain at his post.

Neither the Bank of England nor the New Zealand government believed that a central bank would solve the depression, however, and the formation of a central bank was not regarded as a matter of urgency in Wellington. Gordon Coates, who became minister of finance in January 1933, was the main supporter of the scheme, which finally secured parliamentary endorsement later that year. The Reserve Bank opened for business in 1934 and by 1935 it had 60 staff. It was two-thirds owned by the government and one-third by private shareholders. At the request of the New Zealand government, the first governor, Leslie Lefeaux, was recommended by the Bank of England. The Reserve Bank became the main source of reserves for the trading banks. Monetary separation from Australia was reinforced, but the central bank did not initiate New Zealand’s recovery from the depression – recovery was already in progress by 1934.

  1. Bank of England Archive, OV59/1, Notes of informal meeting between the Governor and Downie Stewart at the Hotel Metropole, London, 15 September 1932. Back

Reserve Bank, 1936 to 1984


In 1936 the new Labour government nationalised the Reserve Bank. Labour also amended the Reserve Bank Act to give the minister of finance the power to direct the central bank’s policy. Though the government did not interfere on everyday matters, it did at times instruct the Reserve Bank to extend credit to the public sector, especially in aid of the state housing programme and the dairy industry. Growing state involvement in central bank policy-making was a global phenomenon in the mid-20th century. Monetary economists and historians often lament the disappearance of central bank independence in the 1930s and 1940s, but the relationship between central banks and governments was understood at the time as a partnership.

Home sweet home

Returning from a stint overseas in 1982, assistant governor Lindsay Knight compared the Reserve Bank to ‘an old and comfortable slipper … Sitting down again in the same old comfortable office with the same old tediously tasteful decorations, facing again the gracefully presented morning tea tray with those fresh home-made buttered scones that have always been the envy of visiting Treasury officers, one knows that this is home indeed.’1

Tightly regulated economy

From 1938 until 1984 the New Zealand economy was tightly regulated, with the aim of ensuring full employment. The key was to insulate New Zealand from economic shocks, whether transmitted from overseas or originating in the domestic financial sector. Within this framework, the function of the Reserve Bank was to manage a host of controls over foreign transactions, bank lending, interest rates and bank reserves. There were also restrictions over the sort of business each sort of financial institution could accept. For example trading banks were prevented from competing directly with savings banks. Denied the opportunity to compete aggressively for new business, the banking industry became inefficient.

Instability, 1970s

In the mid-1970s the New Zealand economy entered a period of instability. Two oil crises, rising inflation, balance-of-payments difficulties, erratic economic growth and the end of full employment all taxed the skills of policy-makers. Some younger Reserve Bank officials were already advocating less regulation and the adoption of a more flexible interest-rate policy. By the 1970s many other central banks were trying to influence spending by adjusting interest rates, and some were beginning to set targets for the money supply.

Starting in 1976, Robert Muldoon, the prime minister, experimented with flexible interest rates, but in 1981–82, after the second oil shock, he intensified all controls over the financial sector and introduced a wage and price freeze to halt inflation. Although the Reserve Bank and Treasury warned against these policies, they had lost the confidence of Muldoon, who ignored unpalatable advice. The early 1980s was a period of central bank impotence in New Zealand. By contrast, the Federal Reserve in the United States was then at its most decisive and effective.

Muldoon and the central bankers

The later years of the 1975–84 Muldoon-led National government were difficult for central bankers. Ray White, Reserve Bank governor since 1977, declined a second term in 1982 because he could not work with Muldoon. His successor, Dick Wilks, resigned early in 1984, allegedly at Muldoon’s prompting. Muldoon then appointed Spencer Russell, expecting him to be compliant, but Russell, formerly of the National Bank, stood up to Muldoon’s bullying during the 1984 exchange-rate crisis.

Reforms, 1980s

Muldoon’s government was defeated in 1984. The election campaign was accompanied by a run on the currency, which led to a post-election devaluation. Muldoon charged the Reserve Bank and Treasury with ineptness in the management of New Zealand’s foreign exchange reserves and in the overall conduct of policy during this episode.

To the surprise of most observers, the incoming Labour government scrapped nearly all of the controls over the banking industry and over the balance of payments accumulated since 1938. The exchange rate was floated in 1985. Monetary policy was now implemented through the market. Inflation rose strongly for a while after the end of the freeze, but interest rates were encouraged to rise to levels at which spending was dampened, and inflation was brought under control. The soaring New Zealand dollar reinforced the downward momentum of inflation. Roger Douglas, the minister of finance, was supportive of the Reserve Bank, and a partnership between the government and the central bank was restored. Under existing legislation, however, Douglas was still the boss. The central bank was not yet independent.

  1. Lindsay Knight, Speech to New Zealand Association of Economists After Dinner, 10 February 1982 Reserve Bank Archives, Box A0143 Back

Central bank independence

Legislating for independence

Uncomfortable with the existing Reserve Bank Act 1964, which left the door open to interference by future governments, the new minister of finance, Roger Douglas, resolved to ‘Muldoon-proof’ the Reserve Bank. In 1986 he asked the Reserve Bank and Treasury for advice on remodelling the central bank and redefining its relationship with government. This initiative coincided with the reform and commercialisation of large parts of New Zealand’s public sector, and a global academic debate on the merits of central-bank independence.

West Germany’s Bundesbank, the most independent central bank in the 1980s, was also one of the most successful at containing inflation, but it was not very accountable. One of the principles of public-sector reform in New Zealand was that public-sector entities should be accountable to the government, Parliament or taxpayers. The challenge for the Reserve Bank and the government was to design a framework that combined independence with accountability and delivered low inflation.

Reserve Bank Act 1989

Treasury was inclined to see the central bank as just another state-owned enterprise like the railways. The Reserve Bank countered that it required more autonomy than a state-owned enterprise so that it could resist attempts by governments to subvert sound monetary policy. After considerable argument, and even the threat of a punch-up between Reserve Bank and Treasury officials, a position was reached that was broadly favourable to the central bankers.

The Reserve Bank Act 1989, which came into force in February 1990, assigned the central bank a mandate to strive for price stability and the stability and efficiency of the financial system. There was no mention, however, of other objectives such as full employment or economic growth. The central-bank governor (appointed by the Crown) and the minister of finance were to negotiate periodic policy-target agreements with a view to achieving and maintaining price stability. Once the target was set, the governor – Don Brash between 1988 and 2002 – would have complete freedom to implement monetary policy as considered necessary. If the target was missed, however, the governor could face criticism or even dismissal. The government also retained the power to override the policy-target agreements in extreme circumstances. In addition, the central bank was to become more transparent, releasing timely economic projections and commentary to the public.

The reforms of central-bank autonomy and accountability under the 1989 act were genuine innovations, as was the emphasis on transparency. New Zealand was studied closely by those seeking to reform the Bank of England in the 1990s. The 1989 act set the tone for the Bank of England Act 1998, though in the end the British legislation was less radical.

Muldoon-proofing the Reserve Bank

Roger Douglas told Parliament in the 1988 budget speech that new legislation – the Reserve Bank Act 1989 – would ‘make certain that no future politician can interfere with the [Reserve] Bank’s primary objective of ensuring price stability, or manipulate its operations for their own purposes, without facing the full force of public scrutiny.’1

Inflation targeting

The Reserve Bank was the first central bank to adopt inflation targeting as a monetary policy framework. During the 1970s and early 1980s some central banks – though not the Reserve Bank – set money supply targets (monetarism), with mixed success. Douglas committed the Reserve Bank to developing a method of targeting inflation directly when he appeared on television on 1 April 1988 saying that he wanted inflation reduced to no more than 1% per annum within a couple of years. The inflation targeting framework was formalised in the 1990 policy targets agreements, which set a target for annual inflation of 0–2% by December 1992.

Monetary policy was directed to achieving the inflation target. Until 1999 the Reserve Bank varied the quantity of ‘settlement cash’ – a special kind of money – available to the banking system, but from 1999 onwards its main policy tool was an interest rate, the official cash rate. Since 1990 the target has been adjusted several times. Later policy targets agreements also committed the Reserve Bank to smoothing economic activity whenever possible. For the most part, the inflation targets were hit and inflation remained very low. In fact inflation had already fallen to less than 5% per annum before the introduction of the new framework.

Many other countries, including the United Kingdom and Canada, followed New Zealand’s lead in the 1990s and targeted inflation. Even the European Central Bank established in 1999 introduced inflation targeting, although Germany already had a monetary target.

  1. Appendix to the Journals of the House of Representatives 1987–1990, Vol. II, B6, 1988, p. 11. Back

Independence and supervision

Formal system of banking supervision

New Zealand started to deregulate the financial system in 1984, but the Reserve Bank did not introduce a formal system of banking supervision until 1987. In the interim some banks and other financial institutions made foolish lending decisions, often because their staff were not trained to work in a more competitive and risky environment. The Bank of New Zealand came close to collapse in 1989–90 and had to be rescued by the government. The earlier introduction of banking supervision might have prevented such errors.

The early 1990s saw a vigorous debate within the Reserve Bank over the supervision of banks. The banking supervision department favoured a relatively bureaucratic prudential regime, whereas the economic department thought the emphasis should be on requiring banks to disclose information to the public and financial markets. Reserve Bank governor Don Brash sided with the economists, but did not entirely abandon regulation because of pressure to conform to the minimum international standards in the Basel Accord (international recommendations on banking regulations).

In 1996 the Reserve Bank introduced an unusual variant of prudential supervision based on ‘disclosure and attestation’. Each bank was required to disclose key information about its health to the public and the directors had to attest to its accuracy. This was different from more intrusive regimes, often involving regular on-site inspections, which were the norm in most countries.

Critics said that the Reserve Bank was free-riding on Australian and British supervisors of banks operating in New Zealand, but Brash rejected this gibe. Largely at the initiative of the Reserve Bank, a system of real-time gross settlement was introduced in 1998. This mechanism reduced the risks to the banking system and its clients when inter-bank payments were being settled through accounts at the central bank.

Tenacious banker

Don Brash, the governor of the Reserve Bank between 1988 and 2002, told BBC radio in 1993 that he expected to be sacked if inflation rose above the 0–2% per annum target. When inflation did breach the target, however, Brash kept his job because inflation was still far below the levels common in the 1970s and 1980s.

The 2000s

Fears that the start of the year 2000 would bring chaos to computer systems, especially in the banking industry, proved unfounded. Yet the new millennium did bring challenges. Strong appreciation of the New Zealand dollar in the early 2000s led to renewed concern about the competitiveness of the New Zealand economy, and in 2004 the Reserve Bank was authorised to intervene in the foreign-exchange market to alleviate undue fluctuations in the exchange rate. Intervention was used very sparingly. Following a crisis in the finance company sector the Reserve Bank was given responsibility for supervising non-bank deposit takers in 2008.

Of much greater importance was the global financial crisis beginning in 2007. Fortunately, the Australian-owned banks, which dominated the New Zealand market, had not acted as recklessly as banks had in some other countries. Even so, it became difficult, at least for a while, for the Australian-owned banks and other New Zealand entities to borrow on international markets. As a precautionary measure, the government introduced a temporary guarantee of wholesale and retail bank deposits. The Reserve Bank released more money into the banking system, and, from mid-2008, slashed the official cash rate (which influences the interest rates of the trading banks), in order to underpin banking stability and maintain the level of economic activity. New Zealand was fortunate, during 2007–10, to avoid the worst of the crisis.

Don’t just float

Not all pundits applauded New Zealand's central bank reforms. In the 1990s prominent businessman Hugh Fletcher said that pursuing inflation control but leaving the exchange rate floating cost New Zealand businesses valuable revenue. Other businessmen disagreed. In 2011 Fletcher was on the Reserve Bank's board of directors.

Central bankers

In 1999 a Labour-led government was elected. It continued with largely the same monetary policies as the National governments of the 1990s. Brash stayed on as governor until 2002, when he left to become leader of the National Party, as he did not agree with the government’s economic policies. Alan Bollard, who replaced Brash as governor in 2002, published a lively account of the Reserve Bank’s efforts to manage the 2007–10 global financial crisis. Career central bankers are part banker, part civil servant and part economist.

Most of the action involving the Reserve Bank occurred in the 1980s and 1990s, when it was transformed from a rather dull and sleepy institution into a pioneer in the fields of central bank independence, inflation targeting and prudential supervision. In terms of independence and inflation targeting, New Zealand’s Reserve Bank became an inspiration for central-bank reform throughout the world. By the late 1990s, the pace of change had slowed, although in many respects the Reserve Bank continued to be a model central bank.

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How to cite this page: John Singleton, 'Reserve Bank', Te Ara - the Encyclopedia of New Zealand, (accessed 16 July 2019)

Story by John Singleton, published 20 Jun 2012