Most objective observers agree that, at its present level, the New Zealand dollar is over-valued. Dr Bollard certainly felt that, and I agree with him. Why? Because at its present level, New Zealand is not exporting remotely enough to cover both the cost of the imports of goods and services we buy and the cost of servicing the capital we have borrowed from foreigners. Our growth is unbalanced, and we’re failing to close the gap between our income and that in countries we like to compare ourselves with, like Australia.
But make no mistake: reducing the value of the New Zealand dollar means making exporters and those who compete with imports better off while making the rest of us poorer. In the short-term, a lower New Zealand dollar would reduce the real wages of New Zealand workers and it’s important to remind those calling for a lower dollar that that’s what they are advocating.
Accepting that a lower dollar is a desirable objective if we are to lift our living standards over the medium term however, what can be done?
Unfortunately, there is a large amount of quite ill-informed commentary on this. Some argue that, if only the Reserve Bank were not so obsessed about inflation, it could quite easily cut the Official Cash Rate and so drop the value of the dollar. Other central banks are doing it, so why not the Reserve Bank here?
Yes, cutting the OCR would probably drop the exchange rate but if that resulted in more inflation – which all else remaining the same it would – what would be gained? Yes, the dollar might be lower, but how would that help exporters and those competing with imports if inflation took off? After all, it is not the nominal exchange rate which is important but the real, or inflation-adjusted, exchange rate which determines whether exporters can compete. For several decades after 1945, the New Zealand dollar bought US$1.12, and in the early seventies the exchange rate actually rose as high as US$1.48 at one stage. Exporters would be killed at those exchange rates today because, in the seventies and eighties, New Zealand prices rose relative to those in our major markets. We would gain only a very temporary advantage from a lower exchange rate if domestic inflation quickly eroded that benefit.
Well, why doesn’t the Reserve Bank intervene in the foreign exchange market? The Bank of Japan has spent billions of dollars trying to stop the appreciation of the yen against the US dollar, and has engaged in very extensive quantitative easing as well, so far to no avail. The Swiss National Bank has had more success in capping the rise in the Swiss franc, but has had to spend an amount equivalent to 70% of Swiss GDP buying euros to achieve that – the equivalent in New Zealand would be some $150 billion – and that despite Switzerland having much lower interest rates than New Zealand.
The fundamental question we have to answer is why New Zealand interest rates need to be higher than those in most of the rest of the developed world to keep inflation under control: the answer can’t lie with monetary policy, because inflation in New Zealand has been around the inflation target over the last two decades, and that target is closely similar to that in other developed countries.
The answer almost certainly lies in what drives our collective desire to borrow which well exceeds our desire to save – and that relates to real factors, such as the restrictions on the supply of residential land (which create a perception that land always goes up in value), the very high rate of immigration, the way we tax the income from savings, and so on.
The surest way to bring the dollar down in the short-term (pending moves to change the underlying factors which drive our strong desire to borrow) would be for the government to tighten fiscal policy by cutting government spending or increasing taxes, returning to surplus faster. That would dampen domestic activity, and would effectively oblige the Bank to cut the OCR to avoid the inflation rate falling below the floor of the inflation target. That would enable the exchange rate to fall without any risk of an increase in inflation.
But surely a further tightening of fiscal policy is politically impossible Dr Brash? I’ll leave that for others to judge, but let nobody claim that getting the real exchange rate down is a simple or painless exercise. It’s not. It can be done, but it can’t be done by the Reserve Bank.
Copyright © 2024 Don Brash.