Tackling our reliance on foreign savings to finance consumption and investment is the key to a sustained reduction in the exchange rate, says new Reserve Bank governor Graeme Wheeler.
"This dependency means that we have persistently needed interest rates above those in most developed economies to maintain inflation at target levels similar to those being followed elsewhere," Wheeler said yesterday in his first major speech since becoming governor.
"Policies that increase domestic savings, including reducing the Government's fiscal deficit, and reduce the flow of resources into the public sector and other non-tradeables sectors, would help to achieve a sustainable reduction in the exchange rate."
It was a trenchant defence of the orthodox view of the proper role of the Reserve Bank and what it can and cannot do about the high dollar.
The bank was tasked with maintaining price stability and a stable financial system - the importance of the latter made vividly clear by the global crisis - and those were the greatest contributions it could make to long-term economic growth, he said.
Wheeler acknowledged the downside of the Kiwi dollar's appreciation: slower growth in manufactured export volumes, a decline in investment in tourism and more broadly its effect in retarding a rebalancing of the economy towards sectors which earn the country's living as a trading nation.
It also had important benefits, however, in lower import prices for consumers and producers and lower interest rates than would otherwise be the case.
The Reserve Bank would like to see a lower exchange rate, Wheeler said, if it could be achieved without damaging price and financial stability. But he pointed out the problems with measures often advocated as ways of achieving it, echoing arguments by his predecessor, Alan Bollard.
"If we reduced the official cash rate without sound reasons, the exchange rate might drop initially but rise later when the inflationary implications of the rate cut became clear, especially if the belief was formed in the meantime that the central bank's commitment to price stability was wavering," he said.
Analysis of unexpected OCR changes did not show a strong relationship to subsequent movements in the exchange rate.
Capital controls might be appropriate for some countries in some circumstances, but for a debtor country, an open capital account was essential. "Introducing capital controls, instead of making the necessary adjustments, would damage the credibility and stability of New Zealand's financial sector and increase the real cost of capital."
Intervention in the foreign exchange market was unlikely to have a sustained impact on the dollar, but could have an impact in the short term if the Reserve Bank made the right calls about the exchange rate departing from fundamentals, he said. But even if the exchange rate was exceptionally and unjustifiably high, and bringing it down would be consistent with the bank's monetary policy stance, the bank would intervene only if market conditions were such that it could shift the currency.
"It makes little sense to risk incurring losses to taxpayers by intervening when currency flows supporting the New Zealand dollar are particularly strong," Wheeler said.
"But we will remain vigilant on these criteria and will be prepared to intervene if all conditions are met."
As for quantitative easing, that was "a sign of desperate times for central banks, who in some instances are shouldering the burden of domestic policy paralysis over fiscal policy".
It was for central banks with little or no scope to cut their policy rates any further but still facing major deleveraging and deep concerns about growth. "New Zealand is in a very different situation."