by our view of the output gap. as our forthcoming bulletin article 4 notes, throughout the recent boom we expected the output gap to dissipate rapidly. however, as it turned out the output gap remained positive for an extended period ( figure 3 ). chetwin, w ( 2012 ) “ business cycle review, 1998 – 2011 ” reserve bank of new zealand bulletin 75 ( 1 ), 14 – 27. and chetwin, w and m reddell ( 2012 ) “ monetary policy in the last business cycle : some perspectives ” reserve bank of new zealand bulletin 75 ( 2 ), forthcoming. bis central bankers ’ speeches figure 3 output gap estimates from june quarter monetary policy statements ( percent of potential output ) source : statistics new zealand, rbnz calculations with an extended period of excess demand pressure, average inflation tracked in the upper half of our target zone. while the persistent component of inflation was higher than we would have ideally liked during the business cycle expansion, it did remain anchored within the target zone. that outcome was far superior to our experience of the 1970s when inflation was persistently at double - digit levels. the difficulty of anticipating how long an inflationary shock will last is central to the forecasting process required for monetary policy. in many models that are used for monetary policy analysis, the output gap often quickly returns close to zero following a simple aggregate demand shock, and it is natural to think in those terms. 5 however, the interaction of a persistent aggregate demand shock and inertia in the economy can considerably prolong the time for which the economy is in a state of excess demand pressure. figure 4 illustrates this point by showing the response of an aggregate demand shock with a half - life of only two quarters in a stylised model of monetary policy with typical parameter settings. the point is that excess demand can remain material in the economy long after the underlying shock has gone. here i am referring to the new keynesian style models as described in, for example, woodford, m. ( 2003 ). interest and prices : foundations of a theory of monetary policy. princeton university press ; and benes, j, a binning, m fukac, k lees, t matheson ( 2009 ) k. i. t. t. : kiwi inflation targeting technology, reserve bank of new zealand. bis central bankers ’ speeches figure 4 response of output gap and inflation to a persistent aggregate demand shock rbnz calculations of course, the shocks we face in the economy can be

need to be expanded so we can examine possible sources of the disappointing recoveries, such as say the impact of the overhang of public and private debt on the economy. inflation targeting works, and other lessons for the future despite the challenges and the ongoing shocks to the economy, monetary policy did what it was supposed to do, keep inflation low. the framework maintained the reserve bank ’ s focus on the target and the frequent publication of forecasts forced us to constantly update our views of the economy and the inflation pressure within it. the bank ’ s analysis on the recent business cycle underscores that the inflation targeting framework is an effective way to conduct monetary policy under a range of testing circumstances and that the framework is a useful tool for future inflation control. with low inflation and the credibility of inflation targeting came much lower volatility in the general level of prices. that is helpful for resource allocation, affecting longer term performance, and for macroeconomic stability over the medium term. this credibility was bis central bankers ’ speeches very helpful when the global financial crisis hit. to help offset the very large negative shock the bank started lowering interest rates even while annual inflation was above its 1 to 3 percent target. of course, that is not to say the framework cannot be improved in any way. over the course of the past 20 years or so the framework has evolved to reflect lessons learned and is likely to evolve further in response to new developments. in particular, our monitoring of monetary and credit information has increased in the wake of the global financial crisis. the reserve bank has also been looking into the effectiveness of some macroprudential instruments that may limit build - ups of problems in future periods of rapid credit growth. 7 for details see spencer ( 2012 ) “ prudential lessons from the global financial crisis ”, presentation to financial institutions of new zealand 2012 remuneration forum, may. bis central bankers ’ speeches