RBNZ Paul Conway: Economic Slack Shapes Policy Response to Oil Price Shocks

Reserve Bank of New Zealand (RBNZ) Deputy Governor Paul Conway says “economic slack” should be central to how central banks respond to oil price shocks. Economic slack is defined as the gap between actual output and potential output. Conway argues that when economic slack is sizable, higher oil prices are more likely to produce only temporary inflation effects. In that case, central banks may avoid immediate tightening because businesses and workers can absorb part of the cost increase through weaker demand, lower wage pressure, or reduced pass-through to consumer prices. By contrast, if an economy is near or above capacity (limited slack), similar oil-driven price rises could trigger stronger, second-round inflation risks and justify a more aggressive response. He links this framework to historical patterns. The 1970s oil shocks coincided with relatively low slack in many advanced economies, contributing to stagflation. In 2014–2016, the oil price fall occurred amid significant global slack, and central banks stayed accommodative despite deflationary pressures. Practically, the RBNZ assesses economic slack using multiple indicators: output gap estimates, labor market conditions (unemployment, underemployment, wage growth), capacity utilization, and inflation expectations. The article notes New Zealand currently has moderate economic slack, consistent with a calibrated, watchful approach under RBNZ’s flexible inflation targeting (1%–3% medium-term). Conway also emphasizes communication: central banks should explain why they may “look through” temporary oil-driven inflation, so markets do not misread inaction as disregard for inflation. For markets, the key takeaway is that oil volatility may not translate into uniform monetary policy moves across countries; differences in economic slack can drive divergence in rates expectations.