parts of the tradables sector, particularly for those not directly benefiting from the recent rise in world commodity prices. with new zealand ’ s current account deficit sitting around 9 percent of gdp, it is our view that the exchange rate cannot be sustained at current levels over the medium term. does trying to lower the new zealand dollar run counter to monetary policy and the reserve bank ’ s low inflation objective? we do not believe so. intervention is about seeking to moderate the trend in the exchange rate and rebalancing monetary policy pressure. it does not fundamentally alter monetary policy and does not signal a future easing of conditions. the direct liquidity impact of fx interventions is always offset via the bank ’ s money market operations. the mechanics of foreign exchange market intervention are quite simple. the reserve bank acquires foreign currency reserves by selling new zealand dollars. this activity may be limited by the amount of foreign reserves we are prepared to accumulate ; but is not limited by the bank ’ s ability to supply nz dollars. in this sense, intervention to lower the nz dollar is less restricted than in the reverse situation where intervention is working to support the nz dollar by running down reserves. many countries around the world have policies which allow foreign reserves to be built up as the exchange rate rises and reduced when their currencies come under pressure. unlike many commercial traders, the reserve bank has the scope to hold additional foreign reserves for an indefinite period. when the exchange rate eventually falls to a more sustainable level, the holding of foreign reserves should become profitable as their value will increase in new zealand dollar terms. claims by some observers that the bank has somehow “ thrown away ” taxpayers ’ money by intervening simply do not stack up. fx intervention is a supplementary monetary policy tool and is considerably less potent than the central ocr instrument which has an important influence on the trend of the exchange rate. as noted in the bank ’ s june monetary policy statement, the outlook for the ocr will depend on how inflation pressures evolve over the months ahead. evidence that inflation pressures are abating will be an important step in seeing the exchange rate return to more sustainable levels.

##ationary monetary policy since the late 1970s, and by the early 1980s most oecd countries were announcing some form of money or credit target in an attempt to convince public and markets that they were taking the challenge of controlling inflation seriously ( reddell, 1999 ). but the focus internationally was on these ‘ intermediate ’ targets – the quantity of money or credit – rather than targeting inflation itself. intermediate targets were thought to be informative for monetary policy as they were 1 bernanke et al. ( 1999 ) provide a widely - cited definition of inflation targeting. 2 italy, greece and portugal all published single year targets for inflation at times during the early 1980s, and sweden briefly operated a form of price level targeting in the 1930s. however, none of these provided a complete, sustained structure for inflation targeting of the kind now understood by the term. in the 1970s and 1980s, west germany conducted monetary policy in a framework that closely resembled inflation targeting, although it was officially designated as money targeting ( bernanke and mihov, 1996 ). in addition, in 1995 the bundesbank itself drew a distinction between its approach and inflation - targeting, arguing at the time that inflation - targeting was the inferior approach. ref # 7482042 v2. 2 susceptible to a degree of central bank control. however, the extent to which intermediate targets were connected to the objective of price stability was subject to debate. 3 in the 1970s and 1980s, new zealand had a very poor track record of price stability. annual inflation had been around 10 to 15 percent since the early 1970s ( figure 1 ), and was considerably higher than inflation in our main trading partners. a key driver of high inflation in new zealand over this period was government spending, accommodated by generally loose monetary policy ( grimes, 1996 ). there had been episodes of tight monetary policy over this period. but successive governments had been unwilling to face the short - term costs to output and employment that disinflation brought with it, and had loosened policy again. figure 1 : annual cpi inflation ( target range shaded ) source : statistics new zealand. bringing high inflation under control was a key priority for the labour government that came into power in new zealand in july 1984. 4 in 1986, the then minister of finance roger douglas invited officials to explore options for reforming the monetary policy framework, aiming to reduce the scope for political influence that had seen past attempts to control inflation fail so badly. the framework that evolved over the next four years was the cu