Modelling structural change: the case of New Zealand

This paper documents the Reserve Bank of New Zealand's current approach to dealing with structural change, an important feature of New Zealand's recent macroeconomic history after the profound economic reforms undergone in the past twenty years. Traditional estimated macroeconomic models of New Zealand have broken down over time, which led to the mid 1990's creation of the Forecasting and Policy System (FPS). In this paper, we analyse why the FPS has proved more robust to structural change and discuss steps we are taking to develop carefully chosen alternative models to complement FPS. Because those alternative models are clearly subject to structural change as well, in developing them we have looked hard at estimation approaches that allow for structural instability. In this paper, we document the results of subjecting some key nominal relationships to stability tests and explicit modelling of structural change. We find preliminary evidence that New Zealand's inflation targeting regime has caused structural shifts in pricing behaviour and expectations formation.