Competitiveness indicators well out of line

In my post yesterday, buried well down amid long and fairly geeky material, I showed this chart.

wages and nomina GDP phw an unadj.png

Using official SNZ data, it suggests that over the last 15 years or so nominal wage rates in New Zealand have risen materially faster than the income-generating capacity of the New Zealand economy (nominal GDP per hour worked –  a measure that takes account of the terms of trade).   Since a big part of what New Zealand firms are selling when they try to compete internationally is (the fruits of) New Zealand labour, it probably shouldn’t be too surprising that our tradables sector producers have been struggling. As a reminder, we’ve had no growth in (a proxy measures of) real tradables sector GDP since around 2000 –  two whole governments ago.

The OECD publishes a real exchange series, all the way back to 1970, using real unit labour cost data.  Unit labour costs are, in effect, wages adjusted for productivity growth.  The real exchange rate measures compares how our economy has done on this competitiveness measure.


(There are other real exchange rate measures in which the fine details are less stark, but the picture is very similar.)

Broadly speaking, our real exchange rate was trending gradually downwards for the first 30 years of the series.  And each trough was a bit lower than the one before it.  That was, more or less, what one might have expected.  New Zealand’s productivity performance had been lousy relative to those of other OECD countries, and countries with weak relative productivity performance should expect to experience a depreciating real exchange rate.   On one telling, the weaker exchange rate helps offset the disadvantage of the lagging productivity.  On another, given that tradables prices are set internationally, a country with a weak productivity growth performance will tend to have weaker (than other countries) non-tradables inflation.    Another way of expressing the real exchange rate is the price of non-tradables relative to the (internationally set) price of tradables.

But over the last 15 years or so, we’ve seen something quite different.  The real exchange rate isn’t trending downwards any longer.   In fact, there has been a really sharp increase.   Competitiveness, on this measure, has been severely impaired.

It is not as if, after all, productivity growth has suddenly accelerated in New Zealand relative to other advanced countries.  We’ve done no better than hold our own against the median of the older advanced economies, and we’ve been achieving much less productivity growth than, say, the former communist eastern and central European OECD countries.     But on this measure, the real exchange rate recently has been 40 per cent above the average level in the 1990s, and even higher than it was in the early 1970s.

But aren’t the terms of trade extraordinarily high too?  Well, in fact, no.     They’ve increased quite a lot in the last 15 years or so, but here is a chart showing the terms of trade back to 1914 (using the long-term historical research series on the SNZ website and, since 1987, official SNZ data).

TOT back to 1914

Current levels aren’t much different from the average level for the quarter-century after World War Two.

On this OECD measure, the real exchange rate is higher than it was in the early 1970s (the previous peak in the terms of trade).  But since then, productivity growth (real GDP per hour worked) is estimated to have been far less than the median advanced economy experienced over that period.  In other words, the median OECD country (those 22 for which the OECD has data for the whole period) managed productivity growth  of around 150 per cent over 1970 to 2015 (the most recent year for which there is data for all countries) and New Zealand managed productivity growth of only 75 per cent.  It would take almost a 50 per cent increase in New Zealand’s productivity –  all other countries showing no growth –  to recover the relative position we had in 1970.

Competitiveness is a really major issue for the New Zealand economy.  It isn’t so much of an issue for the firms that operate here now –  they’ve survived and adapted.  It is more about the firms that never started-up, or which started up and couldn’t make it, or which started, flourished and found that they could prosper rather better abroad.   As trade shares (of GDP) shrink, in many respects this is a de-globalising economy.

Which made it rather odd to hear the (economist purporting to be the) “acting Governor” of the Reserve Bank declare that he, and the Bank, were comfortable with the level of the real exchange rate after the recent 5 per cent fall.  He declared that the exchange rate was now close to “sustainable, fair value”.    Taking a real economic perspective, it is anything but.

Such imbalances don’t have anything much to do with monetary policy, but they are symptoms of policy failures that need addressing urgently if we are to finally begin to turn around many decades –  stretching back even 20 years before 1970 –  of sustained economic underperformance.


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.

Exports, as seen from the 2009 Budget

I was exchanging notes with someone earlier this afternoon about how the government has lapsed into blather and “making it up” in so many areas.  I was pointing out how doubly sad it was because when the government had first taken the office, the then Minister of Finance –  now Prime Minister –  seemed to have a real concern about some of serious underlying imbalances and indicators of underperformance.  I used to help provide material to his office in support of that.

It is hard to track down old ministerial speeches that far back.  But take the 2009 Budget speech as just one example.  The Minister of Finance said

Indeed export volumes have on average grown by less than 2 per cent annually over the past five years. It has been hard being an exporter in recent times.

noting that

in the long term New Zealand must balance its economy in favour of more investment and jobs in internationally competitive industries.

So how has New Zealand done since?

English on exports

The Minister delivered this speech in May 2009, so presumably the latest data he had available was that to December 2008 (right at the worst of the recession).  In the five years to December 2008, export volumes had indeed –  even with subsequent data revisions –  increased by a bit under 2 per cent per annum.

Export growth had certainly been falling away quite sharply over the previous few years, and those peak growth rates from the five years to 1995 (almost 8 per cent) and to 2003 (almost 6 per cent) were distant memories.  But perhaps a fairer benchmark might not be growth rates to the depth of the severe recession, but perhaps in the five years to the end of the boom.  That seems doubly so because the Minister was arguing that the boom had been severely unbalanced, an opportunity wasted etc.  In the five years to December 2007 (the last pre-recession quarter) export volumes had grown at an average annual rate of 2.7 per cent.

And how are things now?   In his Budget last week, the new Minister of Finance asserted that

Under the Government’s strong economic leadership, New Zealand is shaping globalisation to its advantage.  We’ve embraced increased trade, new technologies, innovation and investment.

In the last five years, export volumes have grown at an annual average rate of 2.83 per cent.   It is a little better than those five years to December 2007.   But if 2.7 per cent annual growth was unsatisfactory, it must be hard to regard 2.83 per cent with equanimity.   Average export growth rates have been much lower under this government than under its predecessor.    Not exactly “shaping globalisation to our advantage……embraced increased trade”.

Now, of course, exports aren’t everything, and we only export so that we can import.  But it is a pretty meagre result.  At least back in 2009, the government could face the challenges squarely (they happened on someone else’s watch).   By now, eight years on, all they seem to have left is falling back on rhetoric, and hoping no one notices the data.

As the (now) Prime Minister noted in 2009, it had been “hard to be an exporter in recent times”.  The real exchange rate had increased a lot during those boom years.    In his 2009 Budget speech the Minister was welcoming the sharp fall in the exchange rate.  Unfortunately –  given the lack of sustained productivity growth to match –  that proved rather fleeting, and it has averaged just as high in the last seven years or so, as it did in the last few years of the previous government’s term.

rerReal exchange rates aren’t things that ministers or governors directly control.  They reflect the balance of (tradables vs non-tradables) forces in the economy.  That balance here –  still –  makes it hard to manage much export volume growth from New Zealand.



Is there a Singaporean idyll?

Winston Peters was interviewed on the weekend TV current affairs shows.  Any sense of specifics on his party’s immigration policy seemed lacking – perhaps apart from something on work rights for foreign students.  But I rather liked his line that while ministers and officials have been telling us for years that we have a highly-skilled immigration policy, all we hear now is all manner of industries employing mostly quite low-skilled people telling us how difficult any cut back in non-citizen immigration would be.

But what really caught my attention was when, in his TVNZ interview, Peters reiterated his view that what New Zealand really needs, in reforming monetary policy and the Reserve Bank, is a Singapore-style system of exchange rate management.    It was also highlighted in his speech on economic policy last week.  It is clear, specific, unmistakeable….and deeply flawed.   It seems to be a response to an intuition that there is something wrong about the New Zealand exchange rate.    In that, he is in good company.   The IMF and OECD have raised concerns over the years.  And so have successive Reserve Bank Governors.   I share the concern, and I devoted an entire paper to the issue at a conference on exchange rate issues that was hosted by the Reserve Bank and Treasury a few years ago, and which was pitched at the level of the intelligent layperson interested in these issues.   Another paper looked at a variety of alternative possible regimes, including (briefly, from p 45) that of Singapore.

What is the Singaporean system?  In addition to the brief summary in the RBNZ paper I linked to in the previous paragraph, there is a good and quite recent summary of the system in a paper published by the BIS written by the Deputy Managing Director of the Monetary Authority of Singapore MAS).

The key feature of the system is the MAS does not set an official interest rate (something like the OCR).  Rather, they set a target path (with bands) for the trade-weighted value of the Singaporean dollar, and intervene directly in the foreign exchange market to manage fluctuations around that path.   There is a degree of ambiguity about the precise parameters, but the system is pretty well understood by market participants.    Interest rates of Singapore dollar instruments are then set in the market, in response to domestic demand and supply forces, and market expectations of the future path of the Singapore dollar.    It has some loose similarities with the sort of approach to monetary policy operations the Reserve Bank of New Zealand adopted for almost 10 years in the late 1980s and early 1990s, and which we finally abandoned in 1997 (actually while Winston Peters was Treasurer).   It is also not dissimilar to the approach –  the crawling peg –  used in New Zealand from 1979 to 1982 (at a time when international capital flows were much more restricted).

There is no particular reason why a country cannot peg its exchange rate, provided it is willing to subordinate all other instruments of macro policy (and short-term outcomes) to the maintenance of the peg.  It is what Denmark does, pegging to the euro.  Singapore’s isn’t a fixed peg, but the macroeconomics around the choice are much the same.

It is a model that can work just fine when the economies whose currencies one is pegging to are very similar to one’s own.  Denmark probably qualifies. In fact, Denmark could usually be thought of as, in effect, having the euro, but without a seat around the decisionmakers’ table.

It doesn’t work well at all when the interest rates you own economy needs are materially higher than those needed in the economies one is pegging too.    Ireland and Spain, in the years up to 2007, are my favourite example.  Both countries probably needed interest rates more like those New Zealand had.  In fact, what they got was the much lower German interest rates.  That had some advantages for some firms.  But the bigger story was a massive asset and credit boom, materially higher inflation than in the core countries, and eventually a very very nasty and costly bust.  Oh, in the process of the boom the real exchange rates of Spain and Ireland rose substantially anyway.    Because although nominal exchange rate choices –  the things that involve central banks –  can affect the real exchange rate in the short-term, the real exchange rate is normally much more heavily influenced by things that central banks have no control over at all.

One can, in part, understand the allure of Singapore. It is, in many respects, one of the most successful economic development stories of the post-war era.   Productivity levels (real GDP per hour worked) are now similar to those of the United States, and places like France, Germany and the Netherlands, and real GDP per capita is higher still.   You might value democracy and freedom of speech (I certainly do), but if Singapore’s achievement is a flawed one, it is still a quite considerable one.  And if Singapore is todaya big lender to the rest of the world, it wasn’t always so. Like New Zealand (or Australia or the US) net foreign capital inflows played a big part for a long time.  As recently as the early 1980s, Singapore was running annual current account deficits of around 10 per cent of GDP.

And the Singaporean model is not one of an absolutely fixed exchange rate.  It is a managed regime (historically, “managed” in all sorts of ways, including direct controls and strong moral suasion).  It produces a fairly high degree of short-term stability in the basket measure of the Singapore dollar.      But it works, to the extent it does, mostly because the SGD interest rates consistent with domestic medium-term price stability in Singapore are typically a bit lower than those in other advanced countries (in turn a reflection of the large current account surpluses Singapore now runs –  national savings rates far outstripping desired domestic investment).  As the Reserve Bank paper I linked to earlier noted

From 1990 to 2011, the average short term Singapore government borrowing rate was 1.8 percent p.a. below returns on the US Treasury bill.

Those are big differences (materially larger than the difference between the two countries’ average inflation rates).  And they mean that Singapore dollar fixed income assets are not particularly attractive to foreign investment funds.  By contrast, New Zealand’s short-term real and nominal interest rates are almost always materially higher than those in other advanced countries.   Partly as a result, even though Singapore’s economy is now materially larger than New Zealand’s, there is less international trade in the Singapore dollar than in the New Zealand dollar.

Winston Peters has talked about wanting a lower and less volatile exchange rate.  He has given no numbers, but lets do a thought experiment with some illustrative numbers.  The Reserve Bank’s TWI this afternoon is just above 75.  Suppose one thought that was, in some sense, 20 per cent too high, and so wanted to target the TWI in a band centred on 60, allowing fluctuations perhaps 5 per cent either side of the midpoint (so a range of 57 to 63).    What would happen?

The Minister of Finance might instruct the Reserve Bank to stand in the market to cap the exchange rate (TWI) at 63.   If our interest rates didn’t change, the Reserve Bank would be overwhelmed with sellers (of foreign exchange) wanting to buy the cheap New Zealand dollar.  After all, you could now earn New Zealand interest rates –  much higher than those abroad –  with very little downside risk (certainly much less than there is now).  In the jargon, people talk about “cheap entry levels”.   There is no technical obstacle to all this.  The Reserve Bank has a limitless supply of New Zealand dollars, but in exchange would receive a huge pool of foreign exchange reserves (it is quite conceivable that that pool could be several multiples of the size of New Zealand’s GDP, so large are the markets and so small is New Zealand).

Ah, but the Singaporean option doesn’t involve interest rates remaining at current levels.  Rather, they are now set in the market.  And so, presumably, our interest rates would fall, probably very considerably.  In the current environment, they might even go a little negative.   That would deal with the short-term funding cost problem associated with the huge pool of reserves.  But what would happen in New Zealand with (a) a much lower exchange rate, (b) much lower interest rates, and (c) all other characteristics of the economy unchanged?   The answer isn’t that different to what we saw in Spain and Ireland.  Asset prices would soar, credit growth would soar, general goods and services inflation would pick up quite considerably.  Of course, there would be more real business investment and more exports, at least in the short term.  And that would look appealing, but as time went by –  and it wouldn’t take many years –  the real exchange rate would be rising quite quickly and substantially (as domestic inflation exceeded that abroad).  Export firms would be squeezed again.   If anything, the higher domestic inflation would lower domestic real interest rates even more, so the credit and asset boom would continue.  And before too long it would end very badly.

That might sound over-dramatic.  And if the ambition was simply to stabilise the exchange rate around current levels, things probably wouldn’t go too badly for a while.  But Peters has been pretty clear that his aim is a lower exchange rate, not just a less volatile one.

The lesson?  You simply cannot ignore the structural features of the economy that give rise to persistently high real interest rates, and a high real exchange rate.  And those features have nothing whatever to do with the Reserve Bank or monetary policy.    They are about forces, incentives etc that influence the supply of national savings, and the demand for domestic investment (at any given interest rate).   All that ground is covered in my earlier paper linked to above.

Of course, the Singaporeans also increasingly can’t ignore those forces.  Decades ago, global financial markets weren’t that well-integrated, and the Singaporean web of controls was pretty extensive.  For some decades, even as Singaporean productivity growth far-outstripped that of other advanced countries, Singapore’s real exchange rate was not only pretty stable, it was falling.  Here is a chart of the BIS measure of Singapore’s real exchange rate all the way back to 1964.   The current system of exchange rate management didn’t start until about 1980.

Sing RER

It was, in many ways, an extraordinary transfer from Singaporean consumers to Singapore-operating exporters.  The international purchasing power the economic success should have afforded consumers and citizens kept getting pushed into the future.

But even in Singapore, these things don’t last forever.  Look at that last 10 years or so, when the real exchange rate has appreciated by around 35 per cent.   The real value of the SGD is still miles lower than where long-term economic fundamentals suggest they should be –  consistent that, the current surplus is still around 18 per cent of GDP –  but there has been a lot of change in its value over that time.  For many firms even in Singapore that must have been a challenge.  With US interest rates near-zero for much of that time, historically low Singaporean rates will have afforded the authorites fewer degrees of freedom than they had had previously.

(The Singapore authorities impose all sorts of other controls, including their compulsory private savings scheme and increasingly onerous direct controls on private credit.  I’m not going there in this post, partly because it will already be long enough, and partly because what I’ve heard from NZ First is about the exchange rate system in isolation).

Singapore is a (hugely-distorted) economic success story in many respects.  Some mix of the people, the policies and institutions, and the favourable geographical location all helped.   Nonetheless, it some ways it is an odd example for New Zealand First to favour.

For example, Singapore has had an extremely rapid population growth, mostly immigration-fuelled, in recent decades.  Here is a chart of Singapore’s population growth and that of Australia and New Zealand.

sing popn

(On my telling, Singapore has had opportunities, and lots of savings, and thus rapid population growth made sense, enabling more of those opportunities to be captured, even while real interest rates stayed lower than elsewhere –  although not, presumably, as low as they would otherwise have been.)

And Singapore’s economy is pretty volatile.  Sadly, the IMF doesn’t publish output gap estimates for Singapore, but the MAS estimates (in that document I linked to earlier) suggest much more volatility than we see in New Zealand or most other advanced economies.  And here is annual growth in real per capita GDP for New Zealand, Australia and Singapore.

sing real gdp

Hugely more volatile than anything we are accustomed to (and in recent years, interestingly, not even materially higher).

And for all that the MAS likes to emphasise the close connection between the exchange rate and inflation, here are the inflation rates of the three countries.

sing inflation

On average, the differences aren’t that large, but even in the last 15 years or so Singapore’s inflation rate has been more volatile than those of Australia and New Zealand.

It isn’t really clear that Singapore’s system is even serving them that well these days.

But what of exchange rate comparisons?  You might have supposed that Singapore’s exchange rate was a lot less volatile than New Zealand’s.  But here, from the RB website, is the monthly data for the SGD and the NZD, in terms of the USD since 1999.


And, yes, the New Zealand dollar is more volatile in the short-term, but even there over the last seven years or so the differences are pretty small.   And if hedging isn’t always easy, particularly for firms without large physical assets, it is a lot easier to hedge those sorts of short-term fluctuations than it is the longer-term real exchange rate uncertainty.  (And, of course, given Singapore’s faster productivity growth, you might still be troubled that our exchange rate has more or less kept pace with theirs, but that is a real and structural issues, not one that can be fixed by fiddling with the exchange rate system.)

As it happens, Australia is our largest trade and investment partner.   Here is how our exchange rate, relative to the Australian dollar, compares with the Singapore dollar relative to the US dollar.


It is an impressive degree of stability.  Again, in the very short term the New Zealand exchange rate is a bit more volatile, but it isn’t obvious that for longer-term planning purposes New Zealand exporters have had it tougher –  on the volatility front at least –  than those operating from Singapore.

And, as a final chart, this one uses the BIS’s broad real exchange rate indices to illustrate movements in the real exchange rates of Singapore, New Zealand, and (another export-oriented development success story) Korea.


Singapore’s real exchange rate has certainly been the most stable of the three, but if anything Korea’s has been more volatile than New Zealand’s.   It would clutter the gaph to have added it, but Japan’s real exchange rate has also been more volatile than New Zealand’s.

There are real exchange rate issues for New Zealand.  The fact that our real exchange rate hasn’t fallen, even as relative productivity performance has fallen away badly, is a crucial symptom in our overall long-term disappointing economic performance.  It has meant we’ve been less open to the world (lower exports, lower imports) than one would have expected, or hoped.   But the issue isn’t primarily one of volatility –  which is mostly what the Singaporean system now tries to address –  but of longer-term average levels.   This real exchange rate symptom appears to be linked to whatever pressures (NB, not superior economic performance) have given us persistently higher real interest rates than the rest of the world.   New Zealand First, and other parties, would be much better advised to focus their analysis, and proposed policy solutions, on measures that might directly address these real (as distinct from monetary) issues.    As it happens, a much lower trend rate of immigration seems likely to be a strong contender for such a policy –  taking pressure off domestic demand for resources, and freeing up resources to compete internationally.     Singapore simply isn’t the answer.


Winston Peters on the economy

Winston Peters gave a speech on the economy yesterday to a Wellington business audience.   Going by Alex Tarrant’s report, the delivered version must have been quite a bit different than the prepared and published text, but here I’m going to focus on the published text.

When I first started thinking about the possible role of immigration policy in explaining New Zealand’s dismal long-term economic performance, the immediate response from the person I sat next to at Treasury was “careful, or you’ll be sounding like Winston Peters”.  In a similar vein (although I stress that it wasn’t the representative reaction –  most people were simply puzzled and didn’t know what to make of it) one manager  thumped the table and with the emotion very evident in his voice declared that it was disgraceful that we were even having such a discussion at The Treasury.

Peters has long been a polarising figure, and particularly so for the denizens of economic orthodoxy (of whom I generally counted myself as one).  And, of course, he has been around for a long time –  first becoming a Cabinet minister the same day in 1990 as Murray McCully, and presumably with aspirations to again becoming a senior minister after  this year’s election.  He has been Minister of Maori Affairs, Minister of Foreign Affairs, Treasurer, and Deputy Prime Minister.  Very few ministerial careers will have spanned a longer period –  Sir Keith Holyoake at 28 years is the longest I could think of.

And yet there has always been the question of what he has actually achieved, or delivered.  At present, the list of concrete New Zealand First achievements includes the Super Gold Card, some stuff about cheaper doctor’s visits for children, and……..well, not that much else.  That isn’t to say the presence of New Zealand First has had no other influence on policy over the years (quite possibly some of the government’s immigration policy changes last year and this have been partly pre-emptive measures).  But in office, Peters just has not accomplished much.

That is true of monetary policy –  long one of his bugbears.   He negotiated a new Policy Targets Agreement when he became Treasurer in 1996.  That agreement slightly increased the inflation target –  mostly reflecting actual outcomes which had been in the upper half of the previous range.  But even that agreement was a very long way short of the pre-election rhetoric.    And once the agreement was signed he never gave the Bank any subsequent trouble.   We managed to do some really daft stuff under his watch –  the infamous MCI experiment –  but he never called us out on it.  He served as Foreign Minister under Helen Clark, and while he seemed to be a safe pair of hands in that role, his biggest achievement seemed to be securing a much bigger budget for MFAT.  Somehow, I suspect that was not one of the priorities of his voter base.

And, of course, it is true of immigration policy.  As I wrote about here, despite all the rhetoric –  much of which I think was touching on, or prompted by, legitimate issues and concerns – there was nothing material in the detailed coalition agreement in 1996, and also nothing in the arrangement with Labour over 2005 to 2008.    Throw into the mix his opposition to asset sales, his unease about foreign investment, his opposition to raising the NZS age and so on, and I’ve long been pretty sceptical of Peters.

And so I turned to an election year speech on economic policy with wary interest.

I liked some of his lines (even recognised some of them).    He is totally right to call out the government for the way they make up lines to try to (a) pretend all is well (or even better) in the economy, and (b) to mask evident points of vulnerability (eg housing problems are “quality problems”).  In his words, from the title of the speech, “the facade of prosperity”.    Productivity is poor and per capita real GDP growth is pretty weak.

And while I wouldn’t word things quite this way

The fact is, massive immigration is neo-liberal, globalist voodoo.
It is an attack on those who believe in the nation state.

As a general proposition, I think the ideology of large-scale immigration in much of the advanced world isn’t far from that description.  Based on faith rather than sight.  Our politicians typically aren’t ideologues and like to think of themselves as practical people, but they’ve supped from the same streams of thought, and seem indifferent to the lack of hard New Zealand specific evidence on the benefits to New Zealanders of their preferred approach.  For many, as Peters put it,

In their make-believe world immigration is a free good – a gift.

I’ve been pretty critical of the ex post government “spin”, that attempts to suggest that all is rosy.   But Peters portrays it as the fruit of some deliberate and different economic strategy adopted by the current government.

Every country could flatter its economic growth by turning on the immigration tap.

But only NZ has seen governments reckless and irresponsible enough to try it.

In fact, to a considerable extent the current government has been running much the same immigration policy as its predecessors, including governments of which Peters was a part.

One can see it in the centrepiece of our immigration policy, the residence approvals target.  It hadn’t changed for years, until a modest cut was announced last year by the current government.  And what of actual approvals?

residence approvals 2017

For the 12 months to March 2017, the number of approvals is a bit lower than the last June year.   Overall approvals fluctuate from year to year, but average approvals under the current government are pretty similar to those under the previous government.

And here, using the MBIE data, is the numbers of people getting a first work visa in each year (excluding for the moment working holiday scheme people).

work visas granted

Not surprisingly, numbers dipped during the recession, but even with the increase in the last couple of years, the total number of people granted first-time work visas was still barely higher than in the last year of the previous government.

There are big differences in two areas.   The first is working holiday scheme arrivals.


Even The Treasury has raised concern about the labour market impact of these visitors, but looking at the chart, it is a pretty strong and steady trend increase going back almost 20 years now.  It certainly doesn’t look like a whole new strategy by the current government.

Students are another matter.  There has been a recent big increase in student visa numbers, although still only back to around the 2002/03 peak.

student visas 17.png

Here, of course, there has been a deliberate policy change by the current government, in allowing many or most students significant work rights while they are in New Zealand.    It looked like, and was, an “export subsidy”, and has probably had adverse implications for New Zealanders at the lower end of the labour market (with commensurate gains to the students and their employers).   But this looks like the only significant liberalisation by the current government.  Otherwise, they’ve largely been running the same (misguided) immigration policy as their predecessors

The student issue aside, I suspect that most of what has happened isn’t strategy –  has there been any sign of a serious economic strategy? –  but of being overwhelmed by unexpected events (while the large scale mediocre New Zealand immigration policy ran on in the background).  In particular, the weakness of the Australian labour market (perhaps reinforced by the increasing recognition of the limited entitlements most New Zealanders have in Australia) means that the net outflow of New Zealanders has slowed markedly, and for longer than most had expected.   The escape valve for New Zealanders for the last 40 years or so isn’t working at present, and New Zealand has to cope somehow.

It is a bit like the larger influxes of settlers back to France, after Algeria gained independence, and to Portugal in the 1970s when Mozambique and Angola gained independence.  Opportunities that once existed abroad were no longer there, and a huge reflux of people put pressure on the home economy.  It boosted aggregate GDP quite a bit –  all these new people needed roofs over their heads –  but it didn’t do anything very evident for productivity or the per capita things that matter.

So I don’t buy the line that the current government set out to supercharge population growth.  It just happened.  Perhaps the protracted weakness of the Australian labour market was foreseeable, but it wasn’t widely foreseen.  If it had been the government could have wound back our non-citizen immigration programmes.   It probably wouldn’t have, because ministers still seem to believe the twin gospels of “productivity spillovers” and never-sated “skill shortages”, oblivious to the way that in aggregate immigration increases aggregate pressure on resources, not eases it. But they could have done something.

As it is, they seem mostly overwhelmed by events, without any real strategy other than a desperate hope that it will all come right, in the meantime all the “made up stuff” serves mostly to try to distract attention from the unbalanced, not very productive, mess the New Zealand economy is in.

The government might well be without a strategy, but you have to wonder if any other party has a serious alternative on offer.  Because in the Peters speech yesterday there was a lot of rhetoric about the past, and talk of how

New Zealand First has comprehensive, common sense economic policies designed to build a strong and resilient economy.

But there wasn’t a single word about they would actually do about immigration policy, in any of its dimensions.

I’ve heard Peters in the past talk of reducing the net PLT inflow to around 10000 to 15000 per annum.   But not even that was repeated in yesterday’s speech –  which, in a way, is welcome, because there is no meaningful way the net PLT inflow can be successfully targeted from year to year.  And there was nothing else, at all.  Even though it is only 4.5 months until the election.

Perhaps Peters thinks he can ride high simply on rhetoric.  And perhaps he can.  Perhaps he is concerned not to be outflanked by the Labour Party, which has also yet to release its immigration policy.  But there was nothing at all in the speech.   I’ve seen references to Peters wanting to set something around Pike River as some sort of “bottom line”, but (with due respect to the families of the victims) there are many more important issues in New Zealand.  Judging from his rhetoric, you might suppose Peters thinks immigration is one of those things.

And so I can’t help wondering if we are being set up for a repeat of the last two times Peters went into government: lots of talk in advance, and no action on immigration policy at all.   If it happens, of course, the establishment will be quietly content.  But nothing fundamental will have changed.

Of course, one can only hope that is true of another area of policy that he did discuss in some detail.

Since the Global Financial Crisis we have been in a new economic era that makes reform of the Reserve Bank Act urgent.

Updating the obsolete Reserve Bank Act is critical to take account of the realities of 2017 rather than using a tool that is now decades out of date.

While we cannot slavishly copy from others, in the area of monetary policy we can certainly learn from the experience of countries like Singapore.

The city-state of Singapore has a population of around 5.7 milllion people in a country hardly larger than Lake Taupo.

They don’t have our advantages but they have achieved an enviable record of growth and stayed competitive through using an exchange-rate based monetary policy.

Singapore has a managed float and has a good record in moderating short-term currency fluctuations to ensure that the Singaporean dollar reflects their economy’s fundamentals.

There is no magic wand to get the dollar down to an appropriate and competitive level – and we have never pretended that there is.

But in today’s environment of historically unprecedented low interest rates, failure to reform the Reserve Bank’s Act to make it fit for purpose is inexcusable.

Reduced exchange rate volatility might be helpful, but it simply isn’t the main game.  And Peters offers no thoughts at all on how the average level of the real exchange rate –  one of the critical symptoms of our economic problems –  might be lowered.    And even if you were after materially reduced exchange rate volatility, a Singapore style policy simply isn’t feasible in a country as dependent on foreign capital as New Zealand is.

All in all, it was pretty disappointing stuff –  the more so, because he isn’t far wrong in calling out the unreality of so much of emerges from the government on economic matters at present.

Monetary policy and the exchange rate

The Herald‘s Claire Trevett was perhaps being just a trifle unfair yesterday in commenting on the Reserve Bank’s “consultative” document on the latest iteration of the increasingly unpredictable LVR restrictions

The Reserve Bank’s definition of “consulting” appears to be akin to North Korean President Kim Jong Un’s

The Governor on the exchange rate tends to bring to mind parallels with the (misremembered) story of King Canute.   Canute was trying to deliberately demonstrate to his courtiers how little command he actually had –  none over the tide and the seas.  But the Governor loftily –  or perhaps plaintively – decrees that “a decline in the exchange rate is needed”, and the market really doesn’t pay that much attention.  The exchange rate did fall a bit yesterday, and has pulled back some way over the last 10 days or so, but the exchange rate today is perhaps only a couple of per cent lower than the average over his whole term to date.  For almost his entire term, he has been lamenting the strength of the exchange rate.

I’ve noted previously that I entirely agree with the Governor that a successful transformation of the New Zealand economy’s growth prospects is likely to require a sustained and substantial fall in New Zealand’s real exchange rate –  a substantial fall in the prices of non-tradables relative to the prices of tradables.  But nothing the Reserve Bank does, or could do, has anything much to do with bringing about that sort of change.  It isn’t some fault or failing of financial markets either.  Rather, responsibility for the persistent pressures on domestic resources that have given us a real exchange rate persistently out of line with our deteriorating relative productivity performance rests squarely in the Beehive.  The choices successive governments make –  and both major parties still defend – explain the bulk of our underperformance.   Here is a chart I ran a few weeks ago.  If anything, I suspect – but of course can’t prove formally –  that we need the exchange rate to fluctuate below that 1984 to 2003 average for a decade or two, not the 20 per cent above that average we’ve had for the last decade and more.

real exch rate

But in the shorter-term (perhaps even periods of several years) monetary policy choices make a difference.  Sometimes quite a large difference indeed.  Notice the big fall in the exchange rate following the 1990s boom.  The TWI briefly fell almost as low, in real terms, as it reached following the 1984 devaluation –  and for the economic elite in 1984/85, one of the big challenges then was felt to be “cementing in” that lower level of the real exchange rate.

During this period around the turn of the century, the NZD/USD exchange rate was below .5000 for almost three years.  At the trough in late 2000 it was around .3900.   What else was going on?

In New Zealand, it was the first year of the new Labour-Alliance government, and the business community did not like the policies, or attitudes, of that government one little bit.  I was head of the Reserve Bank’s Financial Markets Department at the time, and used to go along to Board meetings each month.  One particularly prominent and vocal member constantly wanted to get me to say that the weak exchange rate was all a market judgement on the new government.  I usually pushed back quite strongly.

And here is why.

int rates us and nz

This chart uses OECD short-term interest rate data for 1994 to 2004.  During that period from mid-late 1998 to the start of 2001, New Zealand short-term interest rates were at or below the level in the United States.  It is the only time in the whole post-liberalization period when that has been so.  The respective central banks judged that that was where their own interest rates needed to be to keep inflation at or near target (a formal target in the New Zealand case, and an informal target back then in the US).

It isn’t a mechanical relationship by any means.  Apart from anything else, expected interest rates tend to matter at least as much as actual short-term rates –  ie the expected future path of policy.  And other expected returns mattered too.  Even after the NASDAQ had peaked in early 2000, there was still an important theme around markets of “new economies” (with the tech boom) and old economies.  The NZD and AUD –  not seen as currecies of high tech “new economies” – were very weak in response.

The Governor can’t change the structural fundamentals that influence savings and investment preferences in New Zealand.  But he has our OCR in his personal control.  If he were to cut the OCR to 1.5 per cent, there would still be quite a large margin over US interest rates –  unlike the situation in 1999 and 2000 –  but that gap would be quite materially narrower than it is now.  Perhaps the OCR might even be able to go below 1.5 per cent –  after all, it is not as if the resulting margins to world interest rates would be unprecedented –  but we’d have to see how the data unfolded.

The Governor can’t just set the OCR on a whim.  Instead he is required to deliver on an inflation target.  But we know that New Zealand’s inflation rate has been persistently very low relative to the target the government set for the Bank.   Among the OECD countries where the central bank still has some material monetary policy discretion –  say, a policy interest rate still above 1 per cent –  our inflation rate has also been falling away relative to the median in those other advanced economies (a sample which includes Australia).  Inflation just isn’t a constraint at present –  if anything, it is the absence of enough inflation that is the problem.  And is the economy under mounting pressure?  Well, by contrast with the United States where the unemployment rate is almost right back  to where it was prior to the recession, in New Zealand –  even on the latest SNZ revisions –  (and in the median of those other higher interest rate OECD countries) the unemployment rate is almost 2 percentage points higher than it was prior to the recession.

U rates us and nz

There is simply no sign that the real economy could not cope with materially lower policy interest rates – if anything, the evidence is pretty clear that it could do with the boost (or rather with the inappropriately restraining hand of the Reserve Bank being eased up).

The gap between New Zealand and US long-term interest rates has “collapsed” in recent months –  the gap between 10 year nominal bond rates is now only around 65 basis points.  That suggests that markets actually think quite a bit of policy rate convergence is coming. But they can’t be sure when, as the Governor remains so reluctant to cut the OCR and has been prone to inconsistent communications.  The economic case for a 50 basis point OCR cut next month, foreshadowing further cuts to come, is reasonably strong. I don’t expect the Governor to adopt that policy, but if he is serious about getting monetary policy out of the way of the exchange rate  adjustment he seeks, it is exactly the policy he should adopt.

No doubt, some at the Reserve Bank will continue to cite their estimates of neutral interest rates being around 4 per cent –  as the Assistant Governor apparently recently told FEC.  If you asked me where I though global real interest rates would converge back to over the next 20 years, I too might talk in terms of a 2 per cent real interest rate (so with inflation targets centred on 2 per cent, perhaps something around 4 per cent).  But that is simply not a meaningful basis for making monetary policy today.  We don’t know where “neutral” interest rates are now, but most of the external evidence suggests monetary policy isn’t particularly accommodative at all – rather it has sluggishly adjusted towards whatever has changed in the real economy.  In New Zealand’s case, that failure to adopt a practically accommodative policy is holding the exchange rate higher than it needs to be –  higher than the Governor himself would like.  To that extent, the solution is in his hands.



Exporting: the failure of one small OECD country

The current government has a published target for increasing the share of exports in GDP.  I’ve argued previously that that was unwise, for a bunch of reasons, including the risk that it can encourage measures that might boost exports (to meet the target) but which don’t pass standard tests of good economic policies. I’d probably put enhanced film subsidies in that category –  the export incentives of the current generation.  But, equally, setting targets without any supporting economic strategy to deliver sensible results that meet the target has its own problems.

Despite all that, I suspect no one who cares about improving New Zealand’s medium to long-term economic performance is indifferent to the export performance of New Zealand firms, and the  New Zealand economy as a whole.  After all, the wider world is where most of the potential markets are –  especially for firms from smaller countries.  Perhaps there are examples, but I’m not aware of cases of countries that have markedly improved their economic performance on a sustainable long-term without a robust export sector (and tradables sector more generally) being part of that success.

I showed a chart the other day with a snapshot comparison of export shares in Australia and New Zealand in 1980 and 2014.  New Zealand hadn’t done well.  But how have we done over the decades not just by comparison with Australia, but compared with the wider group of advanced countries?

The OECD has data on exports as a share of GDP going back to 1970 for 27 countries, including New Zealand.  Here is the chart, comparing New Zealand with the median of those OECD countries.

exports as a share of GDP

For an individual country, in particular, there is quite some variability.  Thus, the combination of the sharp fall in our exchange rate in 2000 with high dairy prices temporarily boosted New Zealand’s exports to around 35 per cent of GDP.  But if one focuses on the trends, one could say that broadly speaking we had kept pace with the growth of exports in other OECD countries until around 2002/03.  But over the last 15 years, even though world trade growth slowed sharply late in the 2000s and has never really recovered, New Zealand has fallen well behind.

Only rarely is all the information in a single chart.   This isn’t one of those times.  Part of what has gone on, especially in Europe, is the growth of “global value chains”: whereas previously a car might have been designed and built entirely in Germany, and then exported, now often enough there is a lot of gross cross-border trade in the design and manufacturing phase, before the finished product is sold.  That inflates gross exports (and imports) and overstates the growth in economic value-added associated with exporting.  We don’t have up-to-date value-added data, nor a good long time series.  On the other hand, this didn’t suddenly start becoming an issue in 2003.

We also know that:

  • small countries tend to export and import larger shares of their GDP
  • far-away countries tend to export and import smaller shares of their GDP

Both these points need to be kept in mind. The first doesn’t have any very obvious implications: were Belgium to split in two, exports and imports as a share of the respective  GDPs of Flanders and Wallonia would rise even if no transactions were done differently after the split than before it.    But the distance point does have implications.  For whatever reason, distance is an obstacle to foreign trade, even that in services (it is probably not typically the dollar transport costs, but something about time taken to ship goods, and the physical proximity of people –  customers, potential staff, even competitors), and makes it harder –  all else equal –  for distant places to prosper.  Not surprisingly then, one doesn’t find too many people in very distant places.

But reverting to size, here is how the chart above looks if we focus only on the small countries the OECD has data for.  In 1970 only two OECD countries –  Iceland and Luxembourg –  had smaller populations than New Zealand.  We had just under 3 million people, and at the time Norway, Ireland, Denmark, Finland and Israel had fewer than 5 million people.

exports small countries

The recent divergence is, if anything, even more stark.  Our export share of GDP in 1970 was already low by small advanced country standards –  and had shrunk, as one would expect, during the years of heavy protectionism.  But the gap has materially widened only in the last 15 years.  Some of that will be the (profitable) growth in Europe in cross-border trade as part of the production process. But it certainly isn’t the whole story.

What makes me fairly confident of that claim?  Two things really.  The first is this chart (which I’ve run before), the indicative breakdown of New Zealand’s per capita GDP into tradables and non-tradables sectors.  Something here changed, quite materially, in the early 2000s.

pc gdp components

And the second is our exchange rate.  Here is the real TWI, using Reserve Bank data updated to capture the last few months.

real exch rate

Our real exchange rate has always been quite variable.  But if anything over the last decade or so there has been a bit less variability than in the preceding decades.  And probably more importantly, the average real exchange rate since the start of 2004 has been 20 per cent higher than the average over the previous 20 years (the period for which the Reserve Bank has the data).

That would be great if it had reflected a marked improvement in our relative productivity performance. But, of course, it hasn’t.  And perhaps unsurprisingly our tradables and export sectors have really struggled.

Of course, the real exchange rate isn’t simply a policy lever governments pull.  It is an outcome of other factors –  some policy, some market.  And quite what those factors were is a topic for other days.  For today, I simply encourage to reflect on how poorly New Zealand continues to do, and especially in building and expanding sales to the rest of the world, drawing on the high level of skills of our people, and the talents of our firms.