Thursday 8 March 2012

Dutch diseases, the dollar, and the MPS

Today's Monetary Policy Statement rightly notes that continued strength in the New Zealand dollar means there's less reason for increasing interest rates.* The Policy Targets Agreement requires that the RBNZ keep the inflation rate over the medium term between 1 and 3 percent. There seems to be no pressure on the CPI: iPredict forecasts through September quarter have it between 1 and 2 percent. At the same time, there's no prediction of interest rate hikes through the end of the year (though backing out cumulative probabilities from the sequence of quarterly "What will RBNZ do" forecasts isn't straightforward). I'd worried that the GST hike might have fed through into more wage settlements despite the offsetting income tax cut; that seems not much to have happened and forward-looking expectations are within bounds. Nice call RBNZ; I might just lose my bet with Matt.

The MPS has been interpreted as sending signals about the RBNZ's views on the appropriate level of the dollar; Alex Tarrant takes it as warning of interest rate cuts if the dollar stays high. And the MPS does wonder whether the recent appreciation is justified:
The New Zealand dollar has appreciated markedly since the publication of the December  Statement. This appreciation is difficult to reconcile with developments in New Zealand’s economic environment, having occurred at a time when export commodity prices have tracked sideways. Instead, the exchange rate appears to have been driven upward by a combination of an easing in global monetary policy and recovery in global risk appetite. 
The March projection assumes the New Zealand dollar TWI depreciates modestly over the next few years. Should this not occur, all else equal, the Bank would see less need to increase the OCR through this time. While helping contain inflation, the high value of the New Zealand dollar is detrimental to the tradable sector, undermines GDP growth, and inhibits rebalancing in the New Zealand economy.
But this doesn't translate into the RBNZ now targeting the exchange rate, even if Bernard Hickey wishes it were so. The high dollar automatically keeps the CPI down by pushing down the price of tradeable goods in the CPI basket. So if the dollar stays high, there's less need for RBNZ to do anything on interest rates. And if policy easing elsewhere is pushing up the New Zealand dollar, that might give reason for easing on our own part to avoid falling below the lower band of the PTA, if there's risk of falling below the lower bound. iPredict says 10% chance of inflation below 1% in either of the next two quarters, so it's not looking particularly likely. RBNZ, in my reading, is just reminding folks that its inflation target is bounded both from above and from below and using that to do a bit of jawboning on the dollar.

I'm less than convinced that a high dollar is such a bad thing. Even if dairy prices have been flat over the recent few quarters' dollar appreciation, it's hard to say whether that means that the dollar's current strength is unjustified or whether it means the weakness during the worldwide recession was a temporary thing. If the appreciation is due to "the increase in risk appetite, higher global commodity prices and further policy easing by major central banks", a decent chunk is just a return to the status quo ex ante, and perhaps only a temporary one with Greece looking more likely to have a messy default sooner or later and with reasonable concerns about malinvestments in China. But if the rest of the world is getting better, we're back to folks being willing to take on currency risk in exchange for relatively higher returns available in NZ.

Import-competing sectors face stronger competition when the dollar is high. But it's debatable whether some of those import-competing sectors should even here exist. Book retailing probably shouldn't survive here outside of a few niches in the long term when BookDepository can get books here from the UK, delivered, for a bit more than half of the current retail price. If the worry is that milk exports drive up the price of the dollar and hurt other manufacturing, that's not unlike the current situation in Canada where oil and commodity exports have strengthened the Canadian dollar. Stephen Gordon there is trenchant:
Firstly, the prospect of fewer Canadians making things for foreigners is to be welcomed: what matters for Canadian economic welfare is consumption by Canadians, not making things that will be consumed by non-Canadians.
The Dutch disease story also supposes that the employment losses in the export sector are not offset by employment gains in other sectors. This has clearly not been the case in Canada: the resource boom of 2002-2008 saw a steady reduction of unemployment rates to their lowest level since the Labour Force Survey started collecting data in 1976. Nor were these jobs systematically lower-paying: after stagnating during the 1990s, real median wages saw significant growth during the resource boom -- even in Ontario.
Real median wages here also increased substantially from 1998 to 2009 or so**, with nominal stagnation and some real decline during the recent period.

Commodity price driven dollar appreciation isn't as much a disease as a recommendation to shift resources to their more highly valued uses. We're shifting towards dairy manufacturing and away from other forms of manufacturing. I wouldn't call it a disease in need of treatment.

* Please take the strong caveat that I am not a macro economist. And, while I think I was right in criticizing the RBNZ back in 2005 for being too slack, they were very right and I was very wrong in early 2008 when I worried about their very rapid cuts in interest rates.

**This is a nominal series; CPI here for adjusting. Real median wages up about 18% over the decade.


  1. "Commodity price driven dollar appreciation isn't as much a disease as a recommendation to shift resources to their more highly valued uses. We're shifting towards dairy manufacturing and away from other forms of manufacturing. I wouldn't call it a disease in need of treatment."

    I'm entirely sure what to make of it, but a fairly common argument is that dairy investment is slow (time-to-build?) and intensive (non-substitutable assets?), and significant moves toward it homogenize the production process. If there is a reversal or stagnation of the run-up in the foreign demand for dairy, there could be an extended period (longer than would otherwise be the case) of low output while the production process readjusts. (Throw in "investment adjustment costs" or "financial frictions" if you want to be formal about the inefficiency story, here).


    1. That's going to be true for any sectoral adjustment though. Should RBNZ intervene to make sure that there's never any shift in production? Or to put the brakes on any investments with those characteristics? Not really their remit.

    2. If the nominal frictions exist, then there'd be a (New Keynesian) case for intervention, though not necessarily a strong one. Kinda depends on how large you think the distortion would be relative to other relevant distortions (sticky prices, sticky wages, etc).

    3. Sectoral issues are still not the forte of monetary policy - any structural intervention that can be justified should come from the bank.

      Also, the case for intervention in the face of any "dutch disease" depends strongly on how we view expectations formation - as well as the fact that it is costly to reverse investment. This makes any conclusion an empirical issue, and of the few papers I've seen trying to quantify dutch disease I've never seen one conclusively show that there was an economic loss.

  2. Eric, this time I think you are being far too generous. They've spent most of the time following the statement talking about the exchange rate as a structural "rebalacing" issue.

    In truth, any structural issues are in the scope of Treasury not the central bank - this is the view the Fed sticks to, and its a view that is consistent with the mandates of the individual organisations.

    Add this to the fact that they've never really conclusively shown that the real exchange rate is "too high" (by showing why it is the case) - then add to this the fact that even though household debt is elevated, net household assets are at near historically high levels (relative to income) - and you end up in a situation where I'm extremely uncomfortable with what is going on and the reasoning that is being provided.

    If the Bank truly thinks its responsible for the structure of the New Zealand economy then we are reaching a situation where New Zealand's previously strong economic institutions are nearing failure in my opinion ... and if I hear another person talking about the relative price of tradables to non-tradables without admitting that this just "Baumol's cost disease" - which is justifiable - I think I might pass out.

    1. I think we're differing more in tone than in substance, though I was commenting only on the MPS; I've not seen anything following the statement except a few of Alex Tarrant's tweets. I'd said, though less explicitly, that there's no reason to believe the exchange rate is wrong.

      Agreed that, if "structural" means savings rates and housing vs other investments (bit hard to tell in MPS), it's not really RBNZ's bailiwick. But they only talked about that - I didn't see any indication that they were going to do anything about the exchange rate except inasmuch as it hit the inflation target's lower bound. Blah blah blah, discounted by the markets within hours.

      What did I miss that looked like RBNZ doing something indicating potential action on things outside their remit?

    2. The idea that we need to "rebalance" the economy is most definitely a structural one - and they made it essentially the centre point of their monetary policy statement.

      It isn't just about action, but about how they communicate what their mandate is and what they are responsible for. They are feeding the ideas that we need to favour exports, and that it is the responsibility of monetary policy.