By BRIAN FALLOW
Currency union was not a magic path to substantially faster economic growth or a substitute for policies to lift New Zealand's productivity performance, Reserve Bank Governor Don Brash said yesterday.
It was fundamentally a political question, on which the bank should not take sides, Dr Brash said in a speech to Auckland Rotarians.
He outlined the economic pros and cons, as he saw them, of scrapping the New Zealand dollar in favour of the currency, and monetary policy, of either Australia or the United States:
It might reduce interest rates a little. "By adopting either the Australian dollar or the US dollar we would avoid the need to pay the currency risk premium which savers currently demand for holding New Zealand dollar assets," Dr Brash said.
Over much of the past decade Australian short-term interest rates were appreciably lower than New Zealand's; US rates rather more so.
"The main reason New Zealand interest rates have been so high in the last decade is that through much of that period we have been coping with the hangover of high inflationary expectations, especially in the property market," Dr Brash said.
If New Zealand continued to keep inflation under control and follow a prudent fiscal policy its interest rates could in principle fall below US or Australian ones. Currency union would pre-empt that.
Currency union would eliminate uncertainty in the exchange rate with the partner country.
But currency union would only buy certainty in the nominal exchange rate, not the real (inflation-adjusted) one. Hong Kong's dollar has been tied to the greenback since the early 1980s, but its real exchange rate has appreciated strongly, since its inflation rate has been markedly higher than the United States rate. One result: its manufacturing has departed for China.
Currency union would boost trade with the partner country, by cutting transaction costs and uncertainty. The research on the effects of currency uncertainty on trade was inconclusive, Dr Brash said, but his own subjective view, apparently shared by the business community, was that it would boost trade.
Turning to the "cons" of currency union, Dr Brash pointed to the role of the exchange rate in moderating external shocks.
The sharp fall in New Zealand's export prices in the wake of the Asian crisis led to a fall in the New Zealand dollar in the second half of 1997 and into 1998. Such a fall cushions the exporters to some extent from the impact of the fall in commodity prices by spreading the pain across the whole population, who find their New Zealand dollars can buy fewer imports than before.
"Without our own currency there is an increased risk that a fall in New Zealand export prices leads to no fall in our [new] currency, our exporters have to suffer the full pain of the fall in international prices and may well be forced to lay off staff and reduce output," Dr Brash said.
The major disadvantage of currency union would be the loss of an independent monetary policy to moderate demand shocks and influence our own inflation rate.
Argentina has had a more prolonged recession in the past few years than other major Latin American countries because it has been tightly tied to the US dollar, which has pushed up its exchange rate against many of its trading partners.
"Hong Kong seems to have had a more prolonged recession than many other Asian countries for the same sort of reason."
Smaller countries in the euro zone, like Ireland, have been showing signs of overheating because the European Central Bank's monetary policy has been too easy from their standpoint.
With either an Anzac dollar or simply adopting the Australian dollar, it would be the needs of the Australian economy which would dominate monetary policy decisions. Likewise with adopting the US dollar.
This would probably mean New Zealand's growth and inflation rates would swing around more.
"With no ability to use New Zealand monetary policy to deal with these cycles it would be necessary to use fiscal policy more actively and to encourage more flexibility, both up and down, in prices and wages, to moderate these cycles."
Meanwhile, Dow Jones reports, his Australian counterpart, Ian Macfarlane, in testimony to the federal Parliament, said it would be presumptuous of him to venture an opinion on proposals for a currency link.
"It is more the concern of the smaller of the two countries," he said.
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