Remember the dollar is a price – work from there

Via James I see that the Financial Times has given a strange write-up of the RBNZ speech from yesterday (my view here).

The focus of the FT article is solely on the dollar, which in itself is cool as most of the speech was indeed on the dollar.  But they interpreted the comments a bit differently than I did.

First the exchange rate overvaluation relative to the terms of trade and productivity – yes, this has been the Bank’s view for a long long long time.  Of course this begs the question why, which I think is covered relatively briefly … and this is likely why we end up with differing interpretations.

So they go through ways that policy actions of a central bank may influence the exchange rate.  For some reason the FT means that they are planning to use a bunch of exciting tools to reach some sort of right value.  But lets start with this quote from the RBNZ:

Expectations of what central banks can deliver by way of exchange rates and output and unemployment remain excessively high. This is particularly the case in small open economies.

They are spending the speech discussing the tools they have at their disposal, how little they wil able to achieve with them, and how impractical many of the tools would be.  Again, if we actually though about what a real exchange rate is, and the fact that the RBNZ is talking about it being PERSISTENTLY overvalued in their speech, what matters is the fact that the high real exchange rate is a signal of underlying things in the real economy.  It tis a price, and like all prices it is telling us about fundamentals in the market – which are the actual things we are interested in!

This becomes pretty clear if we reiterate the part of the conclusion that the FT didn’t bold:

But further efforts to improve the level and productivity of capital that labour works with, to reinforce ongoing fiscal adjustment, to re-examine the factors that diminish and distort the incentives to save and invest, and to reduce dependence on the savings of others, have to be a major part of the solution.

FT seems to think the RBNZ is saying:

There are no simple solutions, Wheeler said, but it seems the favoured approach is some combination of lowering cash rates and offsetting the domestic effects via some sort of macroprudential policy

Reading earlier in the RBNZ’s speech they are saying that the OCR doesn’t have a clear impact on the dollar, and they adjust that to meet their inflation target (so not to target the exchange rate independently of it’s impact on inflation), and with regards to macroprudential policy they say:

The New Zealand economy currently faces an overvalued exchange rate and overheating house prices in parts of the country, especially Auckland. The Reserve Bank will be consulting with the financial sector next month on macro-prudential instruments. These instruments are designed to make the financial system more resilient and to reduce systemic risk by constraining excesses in the financial cycle. They can help to reduce volatile credit cycles and asset bubbles, including overheating housing markets, and support the stance of monetary policy, which could be helpful in alleviating pressure on the exchange rate at the margin.

So they are saying they will use macroprudential tools for financial stability reasons – and on the margin this might lower the real exchange rate as well.

They are so far from saying that they will use the OCR and macroprudential tools to “target the dollar” that it hurts me to see this inference turn up.

Also it is interesting to see the FT feel that macroprudential tools in NZ are very unclear:

What does he mean by using macroprudential instruments? Capital controls? Raising reserve rates to offset the effect of cutting interest rates? Those are a couple of ideas we’ve heard floated around but no-one seems very confident of how to interpret that.

When Grant Spencer from the RBNZ has actually come out and stated what they are and what their purpose is – maximum LVR’s and risk-weighting adjustments in capital adequacy ratios to deal with issues of systemic risk.  Anyone who has spent anytime looking at the RBNZ would know exactly how to interpret that 😉

Tbf, the RBNZ does explicitly mention the dollar not being a “one-way bet” – and this may be because they are concerned there could be a “bubble” in the value of the NZ dollar.  This comes in here:

The Reserve Bank is prepared to intervene to influence the Kiwi. But given the strength of recent capital flows, we can only attempt to smooth the peaks of the USD/NZD exchange rate; we cannot determine the level. When the NZ dollar is coming under upward pressure, we want investors to know that the Kiwi is not a one way bet.

This jawboning is cool, but I fear the FT is reading too much into these comments.  The speech was as much about educating us New Zealanders about the limited ability of the Reserve Bank to influence economic variables as it was about talking traders out of a perceived “asset price bubble in the NZD”.