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10
JUN 11

What will it take for a monetary policy shake up?




The New Zealand dollar has reached a post float high against the US dollar and has tracked up against almost all major currencies over the past few weeks. This has reinforced the need for Government policy reform, but there is still a reluctance to take action from the Government and the Reserve Bank.

The correlation between the exchange rate and tradable sector performance is clear from the graph below. The tradable sector has notably fallen away from about 2003 as the exchange rate has remained persistently overvalued over that time.



For exporters outside of commodities, those adding value to commodity exports and those making differentiated products, these currency levels are completely unsustainable.

There seems to be a view that a favourable cross rate with Australia is enough, but simplifying export markets is hardly something to be promoting. The recent down turn in the Australian economy is evidence that relying on one market is inherently risky. The Bureau of Statistics reported that national gross domestic product in Australia had fallen by 1.2 percent in the first quarter of 2011, steeper even than the fall during the worst of the global financial crisis. There are also concerns about a collapse in the Australian housing market which would hurt consumer demand.

The other view promoted by the Government and officials is that high commodity prices lifting our terms of trade go some way to justifying a higher currency. This ignores the fact that capital flows speculating on the Kiwi dollar are 100s of times greater than bilateral trade flows – trade in the real economy is simply not material. Furthermore, an economy that barely missed a double-dip recession and has been hit by earthquakes does not justify a high currency. The only reason currency pressures persist is that other countries are taking action to lower their exchange rates, whether through quantitative easing in the United States and the United Kingdom, capital controls in Canada and Brazil or direct currency management in China and Singapore, while our policy makers sit on their hands.

Without export growth New Zealand will borrow more, sell more assets and disinvest in the productive economy; all trends that reduce our capacity to sustain a trade surplus and erode our ability to service our international debt. Any credible plan to rebalance our economy must deal with those polices that persistently overvalue our currency.
 


tags: monetary policy, exchange rate, reserve bank, capital controls, differentiated products
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