Macroeconomic effects of inflation targeting policy in New Zealand

In this paper we analyze macroeconomic effects of inflation targeting policy in New Zealand using Markov switching model with one time permanent break. Our results show that the inflation targeting policy has significantly changed the inflation dynamics in the New Zealand economy. The Markov switching model clearly detects a structural break date that is very close to the actual date of the policy change. The volatility in the inflation rate shows a considerable reduction after the structural break date. Our results also show that the inflation targeting policy led to a structural change in real GDP growth rate. The policy change significantly reduced the volatility of real GDP growth rate after the break date. We find that there is a lag of about one year and six months between the monetary policy change and its actual effect on output growth.