Exchange rate volatility: the New Zealand story

When Winston Peters talks about the exchange rate two things tend to be emphasised: the average level of the exchange rate (too high –  relative to some benchmark presumably based something like on tradables sector performance or external indebtedness), and the volatility of the exchange rate (too volatile).

Not everyone would agree with him on the first point, but many would.  Graeme Wheeler, former Governor, certainly did, often highlighting structural concerns about the real exchange rate.   With slightly different emphases than Wheeler, I also agree, and have been highlighting for years how our real exchange rate has diverged markedly from the sort of path that differences in productivity growth between us and other advanced economies might have predicted.  But the other common ground between Wheeler and I would be that these imbalances aren’t ones monetary policy can do anything much to fix.

By contrast, I think pretty much everyone would accept that monetary policy choices and regimes make a difference to the volatility of the exchange rate.   New Zealand’s exchange rate –  against the currency of by far its largest trading partner, the UK –  changed only once in the first 30 years of the Reserve Bank’s history.   There was some variability in the real exchange rate –  adjusting for inflation differences –  but not much.

Countries make choices about their exchange rate regimes –  and thus about their monetary policy regimes.   Some choose to fix their exchange rate, some to float, some to form common currency areas, and some to manage a non-fixed exchange rate (eg Singapore).  Of course, choices about exchange rate regimes are influenced by real structural features: it might make a lot of sense to fix to a major trading partner if your two economies are very similar, but it probably wouldn’t if your two economies were regularly exposed to very different shocks, or if there was no dominant trading partner at all.  Exchange rate regimes may change trade patterns a little, but they won’t change the underlying structural differences in two economies.

And there is a difference between short-to-medium term perspectives and longer-term ones.  In the short-to-medium term, all else equal, floating exchange rate countries will tend to have more variable real exchange rates than other countries.  In the longer-term, real structural forces will out.  We had some pretty large adjustments in the last two decades of our fixed exchange rate era.   Often it was good that we did.  When the terms of trade fall (rise) sharply, a substantial drop (increase) in the exchange rate can be a useful part of how the economy adjusts to that change in fortunes.

As a simple illustration of differences in real exchange rate volatility, I took the first two countries on an OECD table (Australia and Austria) and showed their real exchange rate since the start of 1999 when the euro began.

aus and aus rers

The point isn’t that Australia had Austria’s options –  it didn’t (most of its trading partners weren’t simultaneously forming a common currency area) –  or even that it would have wanted that option (in the face of very big terms of trade swings), just that there are huge differences.

And what about New Zealand?  The Reserve Bank did a useful paper a few years ago looking at the volatility issue.   In that paper, they looked back as far as the 1960s.  That had the advantage of looking through specific choices about how the exchange rate is managed –  over that period, we’ve had almost all the types of exchange rate regimes known to man, other than a common currency.     The results suggested that the volatility of the New Zealand exchange rate had been relatively high –  less so for short to medium term horizons, but more so if one focuses on longer-term exchange rate cycles.

But since Winston Peters has been talking about the potential for monetary policy regime changes to affect exchange rate volaility, here I wanted to look at a couple of shorter periods.    The current monetary policy implementation system –  the OCR –  has only been in place since the start of 1999, and as late as 1996/97 we were still using exchange rate “comfort zones” to manage the very short-term variability in the TWI exchange rate.

And who to compare us to?    The BIS has monthly broad real exchange rate indexes dating back to the start of 1994 for 60+ advanced and emerging countries.  The OECD has a couple of quarterly real exchange rate series for its 35 member countries, with complete data for all countries since 1996.  Of course, many of these countries are part of the euro, and I’ve shown results below for both all the individual countries and excluding the individual euro-area countries and including just the euro area as a whole.

There are more sophisticated ways of looking at volatility, but here I’ve just used two measures: the standard deviation of each country’s exchange rate index, and the range (high to low) expressed as percentage of the average value of the respective country’s real exchange rate index.

Here is how we’ve done relative to other countries on the BIS index.  (I’ve shown both the full period of data since 1994 and also just the last 10 years –  in case something is materially different about the most recent decade, but bearing in mind that 10 years is typically only about one exchange rate cycle).

BIS real exchange rate
standard deviation high-low range as % of average
Since Jan 1994
NZ 10.5 46.5
Australia 12.3 54.5
Canada 9.4 40.3
Japan 17.9 54.3
Israel 8.3 32.3
USA 9.2 33.1
Median of all countries 10.4 42.2
Median excluding individual euro countries 11.9 52
Last 10 years
NZ 7.1 36.8
Australia 8.5 41.5
Canada 8.1 34.3
Japan 12 40.8
Israel 4.8 23.9
USA 7.1 23.7
Median of all countries 5.5 23.2
Median excluding individual euro countries 7 28.5

Overall?   Well, our experience looks a lot like that of the median country and a little less variable than Australia’s real exchange rate over this period.   Since I first noticed the phenomenon almost a decade ago now, I’ve also been struck by the fact that exchange rate variability in New Zealand has been less than that in Japan and quite similar to that in the United States.     Over just the last decade, the amplitude of the exchange rate cycle has been larger for New Zealand and Australia than for most of these countries, but that just reflects the fact that both exchange rates fell so far in the 2008/09 crisis/recession –  surely a welcome, buffering, development.  Officials certainly thought so at the time.

I didn’t show Singapore separately, but the variability of its exchange rate over this period was similar to that for the euro-area as a whole, but materially larger than that for most individual euro-area countries.

What about the OECD measure?

OECD real exchange rate (ULC)
standard deviation high-low range as % of average
Since Dec 1996
NZ 14.6 56.7
Australia 16.3 66.4
Canada 12.4 44.5
Japan 18.8 75.1
Israel 11.2 42.6
USA 12.0 36.7
Median of all countries 10.1 40.5
Median excluding individual euro countries 12.1 48.0
Last 10 years
NZ 8.4 33.8
Australia 10.4 41.8
Canada 7.3 23.9
Japan 12.6 48.0
Israel 6.9 26.7
USA 8.6 26.7
Median of all countries 6.8 23.5
Median excluding individual euro countries 7.6 31.7

Still less variable than the exchange rates of Australia or Japan.  And at least over the last decade, little to mark us out from the median of the floating exchange rate countries (ie the series excluding the individual euro-area countries).

This chart is just one index for just one period, but it helps illustrate a few points.

oced rer variability


  • all the countries to the far left of the chart are in the euro (or pegged to it –  Denmark),
  • among the floating exchange rate countries, the variance of our real exchange rate hasn’t stood out over the last decade,
  • even being in the euro is no protection from considerable real exchange rate variability if the fundamentals of your economy aren’t closely aligned to those of the large country(or countries) you are pegged too –  see Ireland and Greece.

I wouldn’t want anyone to go away from this post with a sense that I’m indifferent to real exchange rate volatility.  I’m not.  The extent of the variability in many real exchange rates is something of a puzzle, even when dressed up in “the exchange rate is an asset price” language.  On the other hand, not all real exchange rate variability is a bad thing –  many of the biggest moves see the exchange rate acting as a helpful buffer.   Exchange rate variability may also be more of an issue in a small country, where firms probably have to take their products international at an earlier stage than might be the case in a larger country.

But, equally, New Zealand’s realistic options are quite limited.  We don’t have a single dominant trading partner, with whom our economic fundamentals are well-aligned.    And with structural demand pressures so different from most of the advanced world (ie interest rates that average persistently higher), attempting to solve the problems by simply choosing a big currency to peg to would, most likely, have been a recipe for an Irish mess.

The biggest constraints on growth in the New Zealand tradables sector are the relative scarcity of good opportunities in such a remote location, compounded by the persistently high level of the real exchange rate.  Considered against that backdrop, the volatility of the exchange rate –  real or nominal –  which isn’t that unusual by the standards of countries in our sort of position is likely to be (a) a second or third order issue, and (b) one where attempted fixes could easily leave us worse off than we are now.

Thinking about the euro and common currencies

There was interesting and stimulating piece by Matthew Klein the other day on the FT’s blog Alphaville headed “The euro was pointless”.  I’ve been a euro sceptic from way back, and am still counting the months until it dissolves.   A common currency should be an intrinsic part of common nationality, and if the latter isn’t going to happen neither, generally, should the former.  The exception, where there might be some gains from a common currency, and no real costs, could be if countries’ economies were so similar that they faced the same shocks and the same stresses.

That said, I’m not persuaded that Europe’s current plight can be attributed largely to the creation of the euro.  After all, the whole region is at or near the lower bound for nominal short-term interest rates.  If each of the countries had their own currencies, perhaps some would be doing a little better than they are, but on average interest rates couldn’t be lower, and there is no reason to think that, on average, the real exchange rate would be lower.  The zero bound looks as though it binds more tightly in countries/regions with little or no population growth than in others.

But what caught my eye was when Klein got into his stride with a discussion of  “the most natural currency union never to exist: Australia and New Zealand”.

I presume he is unaware that for the first 89 years of its modern existence, New Zealand to all intents and purposes did enjoy a currency union with Australia.  To the extent that one can even think of a NZ/Aus exchange rate until 1929 (or NZ/UK or Aus/UK ones) they were each 1.  After 1914 it was no longer a matter of law, but the private sector still found it worthwhile to manage the exchange rates to retain parity.  (Of course, prior to 1901, “Australia” was a geographical expression only –  a continent made of up of several different self-governing colonies).  There was no banking union or fiscal union (but a great deal of debt), although labour flowed pretty freely between the two countries in response to differences in economic performance.  In those days, of course, both countries traded primarily with the United Kingdom, and trade between them was not overly important.  Some of the shocks –  see the Australian financial crisis of the 1890s –  were nastily asymmetric.

(Here is a link to an earlier post on the longer-term developments in the NZD/AUD exchange rate.)

What about now?  We largely share the same banks, but not the same banking system (having different currencies and different regulators).  Australia is New Zealand’s largest trading partner, but it is by no means a dominant partner (and some of the trade is simply commodity exports –  oil notably –  where it really doesn’t matter if the product is shipped to Australia, or to, say, Singapore or Japan.)  Foreign investment flows are substantial, although in terms of Australian foreign investment in New Zealand the largest single component is the banks.

Klein argues that we do just fine with separate currencies, but I suspect he undersells the possible costs and benefits in the economic case for a common currency.   If the NZD/AUD is typically one of the least variable of New Zealand’s exchange rates, it is much much more variable than the exchange rate between, say, the Netherlands or Germany.  In just the last three years, the monthly average NZD/AUD exchange rate has fluctuated between 79c and 98c –  a difference of around 25 per cent.  Commodity exporters in the two countries have to live with that sort of variability (and more) in world markets for those products, but in the rest of tradables sectors most of the pricing variability comes through the nominal exchange rate.  Economists haven’t been very successful in identifying the empirical magnitudes of the costs of exchange rate variability, and Klein usefully reminds us of the cases of Hungary and the Czech Republic which, even with floating exchange rate, have become highly integrated with Germany (gross exports to Germany in excess of 20 per cent of each country’s GDP, compared with well under 10 per cent of New Zealand’s GDP in exports to Australia).

Nonetheless, it doesn’t seem plausible that the degree of variability in the NZD/AUD exchange rate is not reducing the amount of trade between the two countries to some extent.  Much of the integration of Hungary and the Czech Republic with Germany is, as he points about, about large scale FDI by the highly capital intensive (and highly internationalised) German car industry –  a scale of manufacturing that neither New Zealand or Australia has.  Fluctuations in the exchange rate can be managed within the balance sheets of the car companies themselves (and for them, FDI is often a way of managing the variability of exchange rates).  But that is not an option for smaller producers.  Typical Australia firms considering supplying New Zealand, and vice versa, have to manage themselves the still-substantial fluctuations in the exchange rate, in a way that small firms in the Netherlands don’t face in dealing with Germany, or those in the South Island don’t facing in dealing with the North Island.  Physical distance is still a barrier that is not going away, but it is hard to believe that the exchange rate is not also an obstacle to growing that foreign trade.  The overall effect on potential GDP might be small, but it must be bigger for New Zealand than for Australia, and….after our performance in the last few decades, every little would help.

But the other side of the picture is interest rates.  As Klein notes, we have had similar inflation rates (actually Australia’s have been a bit higher, reflecting the higher inflation target) but real interest rates in New Zealand have been persistently higher than those in Australia.  There have been brief exceptions, but consider the current (not unrepresentative) situation: Australia’s policy interest rate is 2 per cent, and its inflation target is 2.5 per cent, while our OCR is 2.75 per cent against an inflation target of 2 per cent.  Putting an Australian interest rate on the New Zealand economy in the last 20 years would have been a recipe for rather more rapid credit growth, a bigger boom, higher inflation, and a more serious risk of a nasty economic and financial adjustment somewhere down the track..  That is, after all, pretty much what happened in Ireland and Spain, where a German (or Franco-German) interest rate was put on economies that typically needed rather higher interest rates.

It is why, unless we are signing up to a full political union with Australia, I’d be pretty reluctant to think that a common currency was a reasonable proposition, even though such an arrangement might boost real trade.  Perhaps it would be different if we’d seen a couple of decades in which New Zealand’s real interest rates had persistently averaged very close to those in Australia..  And even then, there would still be that nagging “are you sure about what you are getting yourself into”.

After all, one could easily look at France, Germany, Austria, and the Netherlands and think that a common currency and single policy interest rate worked fine there.  Real exchange rates had been pretty stable for decades (in contrast to, say, NZ/Australia or NZ/UK real exchange rates).

core RER

nz rer

But notwithstanding that, or perhaps even because of it, the unemployment rates in New Zealand and Australia have tracked materially more closely over the last 20 years or so (data for all countries only exists since 1993) than the unemployment rates of France, Austria, or the Netherlands have tracked with that of Germany.  If stabilisation is a concern –  and it is usually does count for rather a lot in modern macro and modern politics –  it isn’t obvious that the euro has necessarily been a great economic choice even for this core group of countries.  In principle, microeconomic policy can deal with these difference, but somehow New Zealand’s and Australia’s arrangement look practically better –  not optimal necessarily (few things are) but not too bad as things are.

differences in U

Then again, if your countries are merging, and becoming a single state none of that may matter.  But there has never seemed much public appetite for that in Europe, and perhaps even less now than there was six months ago.

China, currency adjustments, etc

[For those keen on my skills-based migration series, more posts are coming.  For government officials, and any others, going “yes, yes, you’ve made your point”, I will clearly label them and feel free not to read them]

There is a column in the Dominion-Post this morning, from a well-regarded journalist, Pattrick Smellie, running under the confident heading of “Beijing not starting a currency war”.  I’m sure the Chinese Embassy will have been pretty happy with the coverage.

Making sense of our own central bank is often hard enough, let alone the intentions and motivations of the Chinese state authorities. Early in World War Two Winston Churchill described Russia, newly signed-up to a non-aggression pact with Germany as “a riddle wrapped in a mystery inside an enigma”.  It seems to be a phrase that could readily be adapted to the Chinese authorities.  But as Churchill put it in the same speech, the key to Russia was “national interest”, or perceptions of it.

And, no doubt, no one is setting out to start a “currency war”.  If one actively devalues one’s currency one prefers that no one else follows.  That  is how the competitiveness gains are secured.  Then again, so-called currency wars in the past have sometimes been rather a good thing.  In the Great Depression  the countries that freed their currencies from gold first, and devalued, recovered soonest, and the laggards (big or small) themselves recovered when they too devalued.  In that period, so-called competitive devaluations were a path to a much-needed easing in global monetary policy, and a recovery in global demand.  It wasn’t coordinated and each country acted in its own perceived self-interest, subject to the constraints each faced.  Facing a very severe adverse terms of trade shock, and the temporary closure of UK funding markets, New Zealand was fortunate that it allowed its currency to depreciate against sterling quite early, then benefited from the UK’s own early departure from gold, and then actively devalued again in early 1933.

What, then, of China?  As Smellie ends up acknowledging in his article, in a weakening economy a depreciating currency might be thought of as normal or natural, and China’s economy has been weakening fast –  almost certainly much faster than is officially acknowledged.

The BIS compiles real exchange rate indexes for about 60 countries.  I had a quick look at which countries had seen large real exchange rate changes since the pre-recession period.  Here I compared the average for the last six months with the average for 2005 to 2007.   13 countries have seen changes of more than 15 per cent[1].  China’s has been, by far, the largest change, and the largest increase –  up around 50 per cent.

china rer

It was pretty widely accepted a decade ago that the yuan was undervalued in real terms.  During this period, China was running huge current account surpluses –  something unprecedented in a fast-growing developing country  (Singapore or Korea, at similar stages of development, ran large deficits).  Hand in hand with the undervaluation, gross exports as share of China’s GDP had doubled from the early 1990s to reach almost 36 per cent in 2006.    Getting a good handle on true Chinese productivity growth isn’t easy, but there was pretty good reason, whether from the trade data or from productivity differentials, to have looked for a real yuan appreciation.

But a 50 per cent appreciation  – a considerable proportion of it in the last 12-18 months as the US dollar has strengthened –  is a very large move.  And, in conjunction with the much lower growth in global demand following the 2008/09 recession, the whole basis of China’s growth model has changed.  From a substantially export-driven model, China moved to relying on one of the biggest credit-led investment booms in history –  and, given the absence of market disciplines in China, perhaps the riskiest.  Credit to GDP soared.  Most of it has been domestic credit, but in the last few years there has also been a great deal of foreign debt taken on by Chinese borrowers.   Investment also soared –  from under 42 per cent of GDP in 2006 to more than 48 per cent by 2011.  Those are huge shifts.  And exports shrank back, from 36 per cent of GDP in 2006 to 23 per cent last year.  Again, a huge shift.  GDP was still growing, but much more slowly than it had previously, and with much less evidence of sustained productivity growth.

Against that backdrop, from a purely macroeconomic perspective, the idea of a depreciation of the real exchange rate must look quite attractive to some in Beijing.  Pursuing its own perceived national interests  no doubt, the Chinese credit boom of recent years has provided a lot of support to global demand, at a time when it was very weak, but the aftermath isn’t pretty.  It rarely is after credit booms –  see Spain or Ireland, or New Zealand post-1987.  With weakening domestic activity, and global growth that is still pretty subdued (at best), the Chinese authorities seem to have two broad short-term options.  Stimulate demand by gearing-up for one last government-inspired credit—based splurge, further exacerbating their own problems, or look towards tapping a bit more of the potential global demand for the benefit of their own producers.   (Of course, the third option would be a domestic cost- deflation, but the Greek model doesn’t seem to have much to commend it.)

People often point out that China’s consumption share of GDP is very low, and suggest a reorientation towards a more consumer-led economy.  But on the one hand those changes are likely to be slow –  and as Shang-jin Wei has pointed out , for example, things like the male-female population imbalance may be structurally driving up savings rate.  Perhaps as importantly, people are typically only willing to spend more if they are confident of their own future incomes.  At the end of a credit boom, with Chinese firms no longer securing the export growth they once were, that security isn’t unquestioned.

In a normal country, weakening demand at the end of a credit boom would naturally be followed by easing domestic monetary policy and a falling real exchange rate.  It is what happened in much of the West in 2008.   China has room to ease domestic monetary policy, but easier domestic policy almost inevitably puts more pressure on the exchange rate.  China has fairly large levels of foreign reserves (as a share of GDP) but expectations can change rapidly, and as many previous countries have found reserves can dissipate rapidly.  Plenty of capital is already flowing out of China.

I’m not suggesting any great insight into what the Chinese authorities were thinking earlier this week. In many ways, a lower real exchange rate would normally make a great deal of sense.   But these aren’t normal times.  As I noted earlier, the depreciations in the 1930s led to looser monetary policy globally.  There was no “beggar thy neighbour” dimensions to them, and everyone benefited.  And if the rest of the world still had materially positive interest rates, it could be the same now.  Easier Chinese monetary policy, lowering the real RMB might have been followed by some cuts in interest rates in other major economies, to offset the impact on them of the increases in their own real exchange rate.  But few large economies –  and none of the advanced ones –  has any material domestic monetary policy room (although the US can hold off  –  or reverse –  the widely-expected unnecessary initial tightening in its own monetary policy). Even in high-interest rate New Zealand, the policy room is dissipating.  Against that backdrop, any substantial depreciation of the yuan, even if it would be in China’s own macro-stabilisation interests, as its economy has slowed markedly, really could be a threat to the rest of the world.  A stimulus to demand in China risks being substantially at the expense of weaker demand elsewhere, at a time when overall global demand growth (China included) is at best modest, and probably weakening.  More competitive Chinese producers would be in a position to cut prices further –  in an economy where producer price inflation has been negative for a long time already –  posing new global deflationary risks.

Much of the media commentary this week has been about what the Chinese authorities intended.  And understanding that better would be good.  But, in the end, policymakers’ intentions matter only so far, once authorities have set out on a path, however halting, towards liberalisation.  There has been a widespread view until recently that the Chinese would not be willing to devalue the RMB –  whether for reasons for international relations, prestige or simply having bought the upbeat stories about China’s growth prospects.  Meanwhile, Chinese investors have been taking a different view.

This week’s action must have increased the perceived risk of some larger adjustment, whether willingly or not.  Many people have pointed out the size of past substantial devaluations –  I especially liked this piece –  but often enough those large devaluations (or float) were late adjustments, forced reluctantly on authorities who held on, and held on, until they could do so no longer.  No two countries’ situations are ever quite alike, but we shouldn’t assume that even if the Beijing authorities don’t want a large exchange rate adjustment that it won’t happen.

Much of the most recent real appreciation in the yuan reflected the material appreciation in the USD.  Some will recall that the continued appreciation of the USD, to which the Argentine peso was pegged, was one of the final straws that broke the Argentine currency board in 1991.

[1] In addition, Venezuela – which now has extreme currency rationing to defend an official peg – is recorded with a 251 per cent increase in its real exchange rate.

Who has had the stablest current account of them all?

I was reading last night a BIS paper from a couple of years ago about the current account experiences (most recently, experiences of surpluses) of China and Germany. Being a data junkie that led me on to the IMF WEO database, looking at the current account experiences of the various economies the IMF classifies as “advanced”. There are 37 of them (but as ever it is a mystery as to how San Marino makes the list, and I ignore them from here on).

The WEO database has current account data back to 1980, although for some of the former communist countries it isn’t available until the early 1990s. The range of experiences is fascinating:
• Largest deficit was 23.2 per cent of GDP (Iceland in 2006, when the aluminium smelters were going in).
• Largest surplus was Singapore in 2007, 26.0 per cent of GDP.
• Only Luxembourg and Taiwan have not run a deficit in any year since 1980
• Only New Zealand and Australia have not once run a surplus in that period.

I was intrigued by the variability (or in many case, lack of it) of the current account balances. The current account balance is often regarded as a buffer, enabling countries to absorb shocks without disrupting a smooth(ish) path of per capita consumption. But here are the standard deviations of the current account balances (as a per cent of GDP) for each of the advanced countries since 1980 (or for the full period for which there is data for each country, but in all cases at least 20 years).


Some of the results surprised me. Australia, in particular, which has had the smallest standard deviation in its current account balances of any of these countries, over 35 years. For a country with a quite volatile terms of trade, and having a massive investment boom in the minerals sector over the last decade, that is quite remarkable. At the other end of the spectrum is Singapore. Singapore’s current account has been becoming much more volatile but the very high standard deviation also partly reflects a structural (but highly distorted) transition from some of the larger current account deficits in the sample, back in early 1980s, to the largest surpluses more recently.


A stable current account deficit is neither obviously good nor obviously bad.  It depends on the shocks the particularly economy has faced. And the exchange rate regime plays a part (although of course, the choice of exchange rate regime should depend, at least in part, on the sorts of shocks the economy faces).

Only four of these 36 countries have had a floating exchange rate for the whole period since 1980 – the United States, the United Kingdom, Canada and Japan. All four show up as having had relatively stable current account balances. We could add in Switzerland – with a brief deviation from floating quite recently – and Australia, which has floated since 1983. Five of the six are then among the countries which have had the most stable current accounts, and Switzerland has been around the median. New Zealand’s experience also sits with this stable group, again despite having had some of the most volatile terms of trade of any of the advanced economies.

What about the other end of the spectrum? Of the 10 countries which have had the most volatile current account balances, only Taiwan and Norway now have floating exchange rates. Iceland’s floated freely for a while, but is now managed, as is Singapore’s.

As one would expect, it looks as though in floating exchange rate countries, the exchange rate has reduced the extent of the variability in countries’ current account balances. That isn’t surprising, and it is consistent with formal New Zealand work on how the exchange rate has responded to commodity prices and/or the terms of trade. But it might not always be a desirable feature either. Some shocks will be domestic in nature, and in principle it might be better to absorb them in greater variability in the current account rather than in the exchange rate. And if the terms of trade are volatile, there might also be a case for allowing more of the variability into the current account, rather than immediately seeing the real exchange rate move against producers in all other tradables sectors (eg if dairy prices soar, a higher exchange rate might smooth the effects on dairy farmers, but could greatly complicate life for other tradables sector producers).  If the terms of trade shock is lasting, the real exchange rate will rise eventually, but if not then perhaps less variability in the exchange rate might have some advantages.

Simple charts like this don’t lead to policy conclusions. After all, one of the big challenges firms (and households and governments/central banks) face is knowing which shocks are temporary and which are permanent.  We need a regime that is robust to our uncertainty about the shocks.  And any consideration of a more-fixed exchange rate for New Zealand would run into the complication of the long-term differential between our interest rates and those abroad. (At the extreme, a fixed exchange rate would equalise nominal interest rates, but wouldn’t itself change the conditions that had required the difference in real interest rates in the first place).

I’ve tended to be a defender and advocate of the floating exchange rate regime for New Zealand – not necessarily as a first best option, but as better than any of the feasible (and freedom-respecting) alternatives for the time being. On the whole, I still think that is probably the right conclusion, but I do find it a little surprising, and perhaps a little troubling, that New Zealand has had one of least variable current account balances among advanced economies in the last 35 years. The positive dimension of that is that New Zealand never faced a serious external funding crisis in that time (unlike the Baltics, or Korea, or Greece or Portugal). But it hasn’t exactly been an untroubled time for New Zealand – it is a period that encompasses Think Big, huge swings in fiscal policy, credit booms and one bust, financial crisis, considerable variability in the terms of trade, and so on.

Oh, and this was the chart I first went looking for: There is a loose, but positive, relationship between each country’s average current account balances over 1980-1994 and those now.  Countries that had deficits back then tend to have deficits now, and those which had surpluses then tend to have surpluses now.

cab correlation