Monday 15 October 2012

Exchange rates

Michael Berry looks at New Zealand's exchange rate in this weekend's Christchurch Press. I provided a few comments; he's quoted me accurately. I'm copying below what I'd sent Michael, not because he's gotten anything wrong, but rather because it seems a waste to lose the bits Michael didn't use. The paragraphs answer questions about which he'd asked me to comment.
“The exchange rate reflects a complicated mix of foreign demand for New Zealand assets and exports, domestic demand for foreign goods and assets, domestic savings rates, and trader expectations about what will be happening with real asset returns in New Zealand relative to other countries. Trying to push it around without thinking hard about the reasons that it’s currently high isn’t without risk. If there are structural problems in the economy that, if fixed, would reduce the exchange rate, that would be a good thing – but mostly because those problems are worth addressing regardless of the exchange rate. For example, we rely on capital imported from abroad because a reasonable proportion of domestic savings are invested in housing. Fixing land use policy to reduce the cost of housing would free up some capital for domestic investment, reduce demand for foreign capital, and help push down the dollar.”

“A lower dollar could help some exporters in the short to medium term, but we have to remember the mechanism by which this works. A low dollar helps exporters by reducing the real wage they pay to their employees. At the same time, it increases the cost of machines and equipment that manufacturers import – our manufacturers losing access to those goods hurts us. In the medium to longer term, wages, in New Zealand Dollar terms, are bid up. And then exporters suffer again the next time that the exchange rate rises and they’re stuck with a wage bill that’s high compared to their export earnings.”

“There is absolutely no good reason for New Zealand to be considering quantitative easing. Quantitative easing is a policy that you try when you’ve reduced nominal interest rates to zero, have indicated that long term rates will remain at zero until inflation expectations come back up, and still have inflation outcomes that are at or below the bottom of the Reserve Bank’s target band. We are not in that world. If we tried it now, with so many other options still available to RBNZ if needed, our central bank’s international credibility would be completely shot. It would be like cutting off your hand because you had a hangnail.”

“A pegged currency also is a last-resort kind of policy. If different countries are affected by different economic shocks, independent currencies give economies ways of easing those shocks. A pegged exchange rate effectively means that you’ve given up having an independent monetary policy. That’s not a bad idea if you have a terrible central bank and you’ve not otherwise been able to establish central bank credibility, but it’s a particularly bad idea for a small open economy subject to idiosyncratic resource-price shocks and with a decent central bank.”

“The Tobin Tax is another of those ideas that sound good on paper – stick it to the speculators! – but risk being pretty awful in practice. The transactions tax is meant to reduce currency volatility by requiring that the expected returns from any trade be higher before anyone make the trade. But, there is reasonable argument that this kind of tax instead can work to increase volatility – it opens up the bid-ask spread on a currency and thins out trading markets. Further, New Zealand Dollar exchange rate movements seem to be on longer cycles than we might expect would be smoothed by a transactions tax. Even if this kind of tax reduced volatility, it would seem likely to do more to reduce intraday volatility than the longer term increases and decreases in the dollar that New Zealand experiences. Those persistent swings seem more likely to reflect fundamentals.”

“Fundamentally, New Zealand has a high exchange rate because we’re an attractive place for foreign investors to put their money. Our relative lack of domestic savings in things other than housing means that the returns on other kinds of investment here are relatively high. Because we have decided to impose very tight limits on urban growth, preventing our cities from either increasing in density or expanding at the fringes, property prices have been something of a one-way bet. So it isn’t surprising that Kiwis choose to put a lot of their savings into housing. Changing land use policy so that households could choose to put a bigger portion of their savings into the real economy would reduce our need for foreign capital and would help reduce pressure on the dollar. It’s a policy worth doing for its own sake, and if you want a lower dollar, it would help to work to that end.”

“The most important thing that the government can do in the next year is start fixing land use policy. Current policy hurts young people trying to get into their first homes and consequently helps encourage them to move overseas; it also embeds a lot of fragility into our cities in case of disaster. Imagine what Christchurch would be like today if, after the earthquake, developers had quickly been able to get a pile of new subdivisions up on the edges of town. Instead, we’re only now seeing consents issued for developers to start building. Christchurch home owners are not even allowed to build a secondary flat with a kitchen into existing homes except under regulations that make it uneconomical to do so; letting them do that would have been one of the quickest ways of getting new housing supply into the market after the earthquakes. Instead, it was forbidden.”


  1. On the other hand, the reporter made a bit of a shambles of my comments; I guess the lesson to talk less. For one thing, despite the opening bit, I wouldn't class money printing as "crackpot", but then nor do I see it as a way to engineer a lower exchange rate.

    The point that I really hoped would make it in there is that over the last two decades, 'inflation' has increasingly come through in the form of assets rather than consumer prices, in ways that we don't understand very well. Any seemingly growth-friendly policies such as quantitative easing just risk more of the same.

  2. There are classes of problems to which printing money can be a solution. I doubt that we're at that point; there are other things the bank yet can do. Agreed that a monetary push would largely feed into house prices.

  3. Thanks for this -- I was hoping someone like you would comment on the proposals. You don't actually say anything different from what I would have guessed as a reader of overseas economics blogs, but it's good to have confirmation from a local expert.

    What do you think about a capital gains tax (on real rather than nominal gains)? Would that also help with the real-estate bias?

  4. Thomas,

    This more my hobby horse than Eric's and is something I have blogged on Offsetting about a fair bit. Just click on the "captial gains tax" label and it will bring up the relevant posts. In short, I am not convinced that there is a real-estate bias (other than there being a problem with land-use regulations), and to the extent that a CGT would remove a distortion between housing and other investment, it would do so at the expense of increasing the distortion encouraging consumption over investment in general.

  5. Um, I don't want to imply anything here, your comments sound great. But I'm a bit puzzled that the reporter asked you instead of a macroeconomist. No offense!!

  6. Good question. I did run a draft by a few others to make sure I didn't screw anything up too badly. Likely called me because I answer my phone.

  7. Ah, there's nothing like having a contact.