Matt Nolan

NZ/Aussie Optimum currency area

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There is a little bit of talk about a ANZAC currency I see.  Lets be honest here, this effectively implies that New Zealand would be adopting the Aussie dollar. I remember arguing about this with my brother a while back, he was pro I was against.  Nowadays, I’m not sure – I’d like to see a few studies on it first.

Now there are costs and benefits from such a currency union.  Pages 633-634 in “Foundations of international macroeconomics” by Obstfeld and Rogoff covers these off as follows:

Benefits

  1. Lower transaction costs.  As Aussie is our main trading partner this is a biggie.
  2. Removes exchange rate risk for trade between nations, both in terms of relative prices and account reporting.
  3. Prevents damage from exchange rate verring from fundamental level.
  4. Makes trade protectionism more difficult.
  5. Added I would also add that, in this case, having the Aussie dollar will reduce the risk premium we have to pay for credit

Costs

  1. Can’t use monetary policy to compensate for region specific shocks – dairy price crashes and we can’t use a lower interest rate to help buffer the fall.  This is the primary concern.
  2. Can’t use inflation to lower public debt – our monetary policy is now determined by Aussie.  However, we don’t do this so it doesn’t matter.
  3. As fiscal policy is independent it can cause issues with splitting “seigniorage revenue“.  With a low inflation target this is not a biggie at all.
  4. Speculative attacks prior to the union.
Matt Nolan

More on exchange rate targeting

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Now in the short term a look at the exchange rate is important for a monetary authority – as it is part of the “inflation targeting” framework.  This is because a stronger dollar implies a lower prices level, which may in turn influence expectations of inflation or the credibility of the central bank to maintain a level of price growth.

However, in a wider context the RBNZ has implied, and BERL has stated, that there is some role for exchange rate management.  Although I do not agree, some recent academic work has come down on their side (ht Econbrowser).

In the paper they say that an increase in home interest rates (in certain circumstances eg a future increase in productivity) can lead to “excessive consumption” at home relative to what we should experience.  Driving this is:

  1. Incomplete markets (required) and sticky export prices (not required but welfare relevant),
  2. Leading to a negative “wealth effect” on our trading partners,
  3. Leading to a suboptimal adjustment in rates (interest rates, and thereby exchange rates) overseas,
  4. Leading to the “wrong” allocation of consumption goods between countries

Although this is the case, I am not sure how relevant it is in the NZ situation.  We are a small portion of trade with our own trading partners, and so an increase in our consumption doesn’t really influence the level or price of consumption in other countries – we are a residual claimant.  As a result, the welfare loss for the “rest of the world” is virtually non-existant – there is no “negative spillover” (read negative externality from our monetary policy). Find out more on trading at https://forextrdr.com/forex-signals-uk.

In this case we are left with the fact that we are a small open economy, and we face a world interest rate.  If there are medium term allocation issues it will be the result of foreign monetary policy, not our own.  And sadly we can’t do anything about that.

Matt Nolan

More commentators on the NZ dollar

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As mentioned here earlier, the high NZ dollar is a symptom of domestic imbalances not a cause – so instead of looking at intervening in the dollar we should be trying to understand exactly what is driving structural issues in the economy.

A couple of articles that follow on in this view are:

  1. Brian Gaynor in the Herald, discussing the incentives towards property investment.
  2. Westpac on the indirectness of any link between the OCR and our structural issues.

With the Westpac piece everyone jumped on the idea that “a lower OCR doesn’t necessarily imply a lower currency”, which is true.  However, I felt the main point was more to do with the inability of monetary policy to solve structural problems in the economy – a point I agree with completely.

Matt Nolan

What an inflation targeting central bank would say

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The RBA just left rates unchanged and they said:

Inflation is gradually moderating, given the earlier decline in energy and commodity prices, and the effects of weaker demand on prices and labour costs. Given the current prospects for demand and output, this moderation should continue over the year ahead. The higher exchange rate over recent months will assist this moderation, at the margin.

So the higher exchange rate is helping them moderate inflation.

Now our Reserve Bank keeps saying that they are worried that the exchange rate will hurt growth.  For this to fit inside our monetary policy story they must be concerned that, if they don’t cut the interest rate, inflation will fall below the target band.  So why don’t they just say that?

Matt Nolan

Don’t start targeting asset prices, target inflation

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ANZ has suggested that we need to broaden the RBNZ target to include asset prices.  No.

Everyone seems to be mixing up the RBNZ’s monetary policy goals and its financial stability goals.  Now, inside of the financial stability targets a good look at asset prices and a dose of prudential regulation COULD be useful.

In terms of monetary policy this does not matter.

The goal of monetary policy is to shift around the interest rate and the supply of money such that “inflation” is constant.  Inflation is the growth in prices that has nothing to do with changes in productivity or changes in relative prices.

Is the CPI imperfect as a measure here, yes.  But it is better than an arbitrary measure that mixes up the price of goods and services in the economy with the price of assets (discussed here).

If I had to target something, I would target expected future growth in the adjusted labour cost index.  But that is a story for another day 🙂 [in fact this isn’t an issue I have covered in the inflation debate yet, I’ll have to have a sit down and think 😛 ]

Matt Nolan

RBNZ on “sustainable” growth

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So on the 14th of July Alan Bollard said the follow in a speech to the Hawke’s Bay Chamber of Commerce:

Sustainable recovery, with rebalancing in demand and the economy’s productive base, is mostly a microeconomic matter. This means households, firms, banks and investors making the right decisions about where to allocate land, labour, capital and funding.

I agree, any issues with the sustainability of growth (read the composition of growth relative to the fundamentals of the economy) depends on the incentives provided to the individual agents in the economy.  If there are issues with the incentives we should ask, “where is the market/government failure here”.

Then on the 30th of July the OCR Review had this in it:

The level of the dollar in particular, is not helping the sustainability of future growth, and brings with it additional economic risks

A higher dollar will lead to lower GDP growth yes.  A higher dollar change the relative price of importing vs producing, leading to more importing yes.  A higher dollar promotes consumption and debt, yes.

BUT, the higher dollar may be the result of rising prices for our goods, or a stronger growth outlook, in which case complaining about it makes no sense.

Furthermore, even if it doesn’t seem justifiable we should recognise that it is a symptom of the imbalances, not the fundamental cause.  If our dollar is “too high” we need to ask what fundamental incentives are out of whack – what policy errors have been made, what institutions are causing problems.

For the RBNZ the dollar is about monetary conditions – if they think monetary conditions are too tight, cut the interest rate to promote consumption now.  Cutting the interest rate because of concerns about the sustainability of future growth makes no sense.  The sustainability issue is not a monetary policy issue.