Prebble: Let's adopt greenback

The strongest political advocate 20 years ago of floating the New Zealand dollar, Richard Prebble, now thinks we should abandon it altogether and adopt the United States currency.

"I think a country the size of New Zealand running its own currency is very expensive. It is why even though our inflation is low New Zealand interest rates continue to be significantly higher than in the US. It's currency risk and it adds maybe 2 per cent to interest rates," Prebble said.

"For me, having the tui on my dollar isn't worth an extra 2 per cent on my mortgage rate, but maybe I'm less patriotic about these things."

Adopting the US dollar would be a more radical step than returning to a fixed exchange rate that pegged the kiwi dollar to the greenback. Such rates can in principle be changed, opening the door to speculative attack.

It would involve giving up an independent monetary policy which set interest rates according to New Zealand economic conditions.

We would be taking the US Federal Reserve's monetary policy as well. Indeed, for Prebble, that would be the point of the exercise.

But research by Professor Viv Hall at Victoria University calls into question the wisdom of "dollarisation".

He set out to discover how the New Zealand economy would have fared in the 1990s if it had had US monetary conditions (exchange rates and interest rates) instead on those it actually had.

He took the Reserve Bank's mathematical model of the economy, poured in the US rates, left everything else the same, and cranked the handle.

What came out was stronger economic growth, but only modestly so and only in the short term.

Inflation, on the other hand, would have been considerably higher and the trade balance considerably worse.

Currency union with their largest market would reduce transaction costs as well as eliminating the commercial uncertainties a variable exchange rate gives rise to.

But there is no guarantee that the benefits of that would necessarily be captured on this side of the Tasman.

A study by Arthur Grimes and Sir Frank Holmes five years ago on currency union with Australia found that, since the 1970s, New Zealand's business cycle had been in sync with Australia's about 80 per cent of the time.

But although Australia is our largest trading partner, only about 22 per cent of our trade is across the Tasman.

If we were to adopt the Australian dollar our volatility against other currencies would be virtually unchanged.