I saw a curious story the other day which reported the Minister of Finance and the National Party spokesperson on finance arguing over who was to blame (or who could take the credit) for the fall in the exchange rate that followed the Reserve Bank’s Monetary Policy Statement. From one side there seemed to be talk of the fall being part of the much-vaunted (but little seen) economic transition – the Prime Minister herself has claimed this – and from the other talk of loss of confidence in the economy, combined with some inflation risks.
Mostly it seems to be a difference about almost nothing. Here is one of the OECD measures of New Zealand’s real exchange rate, for which data are available back to 1970. Obviously, we don’t have Q3 data yet, but I’ve taken the fall in the nominal TWI measure of the exchange rate for this quarter to date (latest observation for the RB website today) and applied it to the Q2 data to proxy a current observation.
Over almost 50 years, there have been lots of ups and downs in the series, even in the period (up to early 1985) before the exchange rate was floating. Some have been the start of something pretty sustained – see the falls in the mid 70s, or after 1987. Others have been very shortlived (see for example the fall in 1986 or 2006 – times when, for example, markets got a bit ahead of themselves in thinking our economy was slowing and interest rates would be falling). Over the full period (and this is quarterly average data, which takes out some of the noise anyway) there have been at least eight episodes when this real exchange rate index has fallen by at least 10 index points (roughly 10 per cent). The last occasion was in 2015, as markets somewhat belatedly realised – not quite as belatedly as the then Governor – that the Reserve Bank’s OCR increases weren’t going to be sustained.
This episiode isn’t one of them. The latest (estimated) observation is a mere six per cent below the most recent peak (18 months ago). And the latest observation is nowhere near the low reached in the second half of 2015.
In fact, the current level of the TWI is 2.4 per cent below the average level for the June quarter. Over the entire life of the series (fixed and floating periods) the average quarterly change (up or down) has been 2.7 per cent. Taking just the floating period (since March 1985), the average quarterly change has been 3.1 per cent per quarter, and if we take just this decade (which, eyeballing things, has been a bit more stable, at least as regards big sustained moves) the average quarterly change has been 2.4 per cent.
Perhaps the fall we’ve seen so far this quarter (or even since the MPS last week) will be the start of something more. If there is a serious global risk-off event, or a serious New Zealand downturn, that probably would happen. But all we’ve seen so far is a change that is about the size of the change one sees, on average, each and every quarter – some up, some down, and most not implying anything very much for the economy.
The idea that the fall foreshadows some promised rebalancing in the economy is pretty laughable. There have been no policy changes to bring about any such rebalancing (any more than there were with the other – larger – falls in the previous 20+ years). Then again, so is the notion that a lower exchange rate – a modest fall at that – is a material inflation risk. The Reserve Bank itself published research a few years back suggesting noting that, in fact, a lower exchange rate has tended to be associated with lower non-tradables inflation, and often – notably when commodity prices are also fallling – with lower overall inflation.