Former Economics Editor of the NZ Herald

Brian Fallow: Reserve Bank bill opens dollar debate

Labour's finance spokesman, David Parker, says New Zealand exporters are hindered by an uncompetitive dollar. Photo / Brett Phibbs
Labour's finance spokesman, David Parker, says New Zealand exporters are hindered by an uncompetitive dollar. Photo / Brett Phibbs

Is help on the way for exporters struggling with a high New Zealand dollar? A private member's bill from New Zealand First leader Winston Peters, drawn from the ballot last week, would widen the "primary function" of the Reserve Bank.

It retains the existing statutory language about the primary function of monetary policy being to maintain stability in the general level of prices but adds "while maintaining an exchange rate that is conducive to real export growth and job creation".

But that assumes that pursuing both those goals at the same time is possible.

It gives no guidance on which has priority should they conflict, as they often do.

It is incorrect to say two things are primary. Two goals can't come first.

And it is no good for politicians just to say to the Reserve Bank governor in effect: "What's the matter with you? The country needs a lower exchange rate. Run away and make it so."

The onus is on the advocates of a policy change, especially if it is to be enshrined in statute, to show that it is at least possible and, if it is, that it does not come at too high a price.

Going soft on inflation would be too high a price.

Reserve Bank governor Alan Bollard has acknowledged the bank considers the Kiwi dollar overvalued, but will not put a figure on how much.

One of the moving parts in that calculation would be the terms of trade, a measure of export prices relative to import prices.

It has fallen 4 per cent from its high in the June quarter last year but the New Zealand dollar, far from falling to compensate, has appreciated nearly 6 per cent since then on a trade-weighted basis.

The terms of trade remains favourable by historical standards, however. It has been higher than this for only three of the past 55 years.

Bollard has also expressed concern about the spillover effects on New Zealand of the unorthodox policies, like quantitative easing, being pursued by some major central banks.

It would be a shame, he said, to have come this far through the global financial crisis without trade wars breaking out, only to have something similar in the way of competitive monetary policy.

Labour's finance spokesman, David Parker, in a speech last week said the Reserve Bank Act was written at a time when the main economic threat was inflation.

"A more pressing challenge now is how our exporters, and their employees, are hindered by an uncompetitive dollar."

We face competitive devaluation abroad and we ignore it at our peril, he said.

But what would truly be perilous would be to respond to adverse developments overseas that we cannot affect by adopting a monetary policy framework which instructed the Reserve Bank not to worry about inflation and concentrate on keeping the exchange rate weak.

Inflation is hardest on the poor and economically powerless, about whom the parties of the left purport to care.

Inflation discourages saving and encourages borrowing, the exact opposite of what the economy needs.

Inflation undermines the international competitiveness of exporting or import-competing firms, as it is the real exchange rate, not the nominal one, that matters.

And by making New Zealand assets cheaper to foreign buyers, it increases the risk of becoming tenants in our own country.

But Parker says the existing regime cannot be seen as sacrosanct.

It has seen a major policy mistake in the wake of the Asian crisis in the late 1990s, driving New Zealand into recession when it did not need to or at least making it worse.

"And in the 2000s the Reserve Bank was much too sanguine about the effect of interest rate differentials in driving liquidity flows into New Zealand that in turn drove consumption pressures," he said.

"I am ready to have a fierce look at whether we get this right in New Zealand or whether we are too accepting of sub-optimal outcomes."

Parker says Labour will support Winston Peters' bill going to select committee.

"We are not necessarily saying his wording is right but the theme that lies under it, that the Reserve Bank needs to have less of a singular focus on inflation and a focus on other factors as well, is right."

Labour favours the Australian system where monetary policy decisions are taken by the bank's board, not by the governor alone, and wants a broader range of interests represented on the board.

Parker concedes that even with its multiple statutory objectives the Reserve Bank of Australia in practice behaves like a conventional inflation-targeting central bank, and that it has not stopped the exchange rate from soaring.

"I have tried to be careful not to sell the changes we have announced so far as making a radical difference. I don't think they do. But they all help."

He emphasises the "monetary policy needs mates" theme.

Its new best friend, he argues, should be a capital gains tax to correct the current signal from the tax system to channel our rather meagre savings into leveraged investment in the property market, rather than into more productive enterprises.

And he welcomes the macro-prudential tools the bank is equipping itself with to moderate credit and asset price cycles, like varying banks' capital buffers or regulating loan-to-value ratios.

Bollard has counselled against expecting too much of them, however. He sees them primarily as relevant to the bank's function as guardian of financial stability, with only a limited supporting role when it comes to monetary policy.

Nor does the bank see the simple, reliable, mechanical connection its critics assume exists between the official cash rate and the exchange rate.


The official cash rate is not the only instrument in the Reserve Bank's toolbox.

It also has a mandate, albeit heavily circumscribed, to intervene directly in the foreign exchange market.

This involves the Reserve Bank creating New Zealand dollars out of thin air and buying foreign currencies with them, thereby lowering the exchange rate.

This is neither a costless nor a riskless strategy, however.

It puts the Reserve Bank on the hook for the differential between New Zealand and foreign interest rates, multiplied by however many billions of dollars were expended on intervention.

It has intervened only twice since the dollar floated in the 1980s.

In mid-2007 when the dollar hit US80c and 76.9 on the trade-weighted index - 4 per cent higher than the TWI is now, by the way - it stepped in and sold $2.4 billion New Zealand dollars over three months.

There was some temporary relief. The kiwi shed about 10c against the greenback. But it soon started rising again and by early 2008 was back over US80c.

The bank intervened again, to the tune of a further $1.6 billion. The dollar fell and this time kept falling, hitting a low of US51c by early 2009.

But that, of course, was during a period when New Zealand and the rest of the world were in a severe recession.

It would be heroic to assume it had much to do with currency intervention by the central bank.

It did, however, allow the bank to sell-down about a third of its position in late 2008 and early 2009 at a profit of around $800 million.

"Since then the appreciation in the currency has resulted in mark-to-market losses on the open position," Reserve Bank economists Enzo Cassino and Michelle Lewis say in an analytical note on currency intervention.

"In 2010 and 2011 the RBNZ's mark-to-market losses were $270 million and $144 million respectively from foreign exchange changes."

They also highlight the differences between New Zealand's situation and those of Japan and Switzerland, countries which have intervened on a much bigger scale.

In both countries, policy interest rates have been at or near zero for some time - without preventing their exchange rates from climbing.

Switzerland had slipped into deflation, while Japan had been there or thereabouts for years.

In New Zealand, by contrast, CPI inflation has held up as low inflation in the tradeables sector has been more than offset by persistent inflation in the non-tradeables sector.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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