Exchange rate moves: trivial in historical context

I saw a curious story the other day which reported the Minister of Finance and the National Party spokesperson on finance arguing over who was to blame (or who could take the credit) for the fall in the exchange rate that followed the Reserve Bank’s Monetary Policy Statement.  From one side there seemed to be talk of the fall being part of the much-vaunted (but little seen) economic transition –  the Prime Minister herself has claimed this –  and from the other talk of loss of confidence in the economy, combined with some inflation risks.

Mostly it seems to be a difference about almost nothing.  Here is one of the OECD measures of New Zealand’s real exchange rate, for which data are available back to 1970. Obviously, we don’t have Q3 data yet, but I’ve taken the fall in the nominal TWI measure of the exchange rate for this quarter to date (latest observation for the RB website today) and applied it to the Q2 data to proxy a current observation.

RER ULC aug 18

Over almost 50 years, there have been lots of ups and downs in the series, even in the period (up to early 1985) before the exchange rate was floating.  Some have been the start of something pretty sustained –  see the falls in the mid 70s, or after 1987.  Others have been very shortlived (see for example the fall in 1986 or 2006 –  times when, for example, markets got a bit ahead of themselves in thinking our economy was slowing and interest rates would be falling).     Over the full period (and this is quarterly average data, which takes out some of the noise anyway) there have been at least eight episodes when this real exchange rate index has fallen by at least 10 index points (roughly 10 per cent).  The last occasion was in 2015, as markets somewhat belatedly realised –  not quite as belatedly as the then Governor – that the Reserve Bank’s OCR increases weren’t going to be sustained.

This episiode isn’t one of them.  The latest (estimated) observation is a mere six per cent below the most recent peak (18 months ago).  And the latest observation is nowhere near the low reached in the second half of 2015.

In fact, the current level of the TWI is 2.4 per cent below the average level for the June quarter.   Over the entire life of the series (fixed and floating periods) the average quarterly change (up or down) has been 2.7 per cent.  Taking just the floating period (since March 1985), the average quarterly change has been 3.1 per cent per quarter, and if we take just this decade (which, eyeballing things, has been a bit more stable, at least as regards big sustained moves) the average quarterly change has been 2.4 per cent.

Perhaps the fall we’ve seen so far this quarter (or even since the MPS last week) will be the start of something more.   If there is a serious global risk-off event, or a serious New Zealand downturn, that probably would happen.  But all we’ve seen so far is a change that is about the size of the change one sees, on average, each and every quarter –  some up, some down, and most not implying anything very much for the economy.

The idea that the fall foreshadows some promised rebalancing in the economy is pretty laughable.  There have been no policy changes to bring about any such rebalancing (any more than there were with the other –  larger –  falls in the previous 20+ years).  Then again, so is the notion that a lower exchange rate –  a modest fall at that –  is a material inflation risk.    The Reserve Bank itself published research a few years back suggesting noting that, in fact, a lower exchange rate has tended to be associated with lower non-tradables inflation, and often –  notably when commodity prices are also fallling –  with lower overall inflation.

 

The real exchange rate mattered in 1985, and it still does

In Christchurch tomorrow evening, Anne Krueger is giving the 2018 Condliffe Lecture.

Krueger is an eminent figure in economics, now in her 80s.  She had a distinguished academic career, specialising mostly in trade and development issues, and she also spent time as first Chief Economist at the World Bank, and then later (until 2006) as first deputy managing director of the International Monetary Fund.   (My lasting impression of her, as an international bureaucrat, was the day she declaimed at a Board retreat about the challenges the IMF faced as a small organisation –  at the time staff numbers totalled about 3000.)

According to Canterbury University

In the University of Canterbury’s 2018 Condliffe Lecture, Anne Krueger will explore the topic: “Is it harder or easier to develop rapidly than it was a half century ago?” in her talk on development and economic growth.

She will argue, we are told

“In this lecture, I shall argue that while the future is never entirely foreseeable, there are a number of considerations that point to greater ease of development now than in the past. These include: the diminishing rate of increase in populations in most low income countries; the fact that much more is understood now (albeit still imperfectly) about development (and especially how not to achieve it); that global markets are much larger; and obtaining information of all kinds is much easier.”

There are also some technological advances that make development easier: mobile phones; continuing discoveries of improved technology in agriculture; advances in materials sciences; and so on.

I hope a copy of her text is made available.

I’m not sure how often Professor Krueger has been to New Zealand, but there is a record of a visit in 1985, when she was at the World Bank.  She delivered a lecture under Treasury’s Public Information Programme, under the heading Economic Liberalization Experiences – The Costs and Benefits (if anyone wants a copy, it appears to be held in the University of Auckland library, but isn’t online anywhere).

As she noted

As a newcomer to the New Zealand scene, it would be foolhardy of me to attempt any assessment of the policies implemented in support of the New Zealand quest for economic liberalization.  It may be useful, however, to discuss what liberalization more generally is usually about, and to attempt to draw on the experience of other countries for lessons and insights that may potentially be applicable –  by those of you more knowledgeable about the situation here than I – in evaluating the progress of liberalization in New Zealand.

It is a very substantial lecture (18 pages of text), drawing on the experiences in previous decades of a wide range of other countries grappling with twin challenges of stabilisation (inflation, fiscal etc) and liberalisation..   The small bit I wanted to highlight –  which saddened me when I first read it a few years ago, and still does, from a “what might have been” perspective –  was about the exchange rate.

Two important lessons emerge from the Southern Cone [of Latin America] experience: failure to maintain the real exchange rate during and after liberalisation is an almost sure-fire formula for major difficulties and the defeat of the effort.  The reason for this is that a liberalization effort aimed at opening up the economy must induce more international trade; it is not enough that there be more imports, there must be more exports.  Since the exchange rate is the most powerful policy instrument with which to provide incentives for exporters, its maintenance at realistic levels which provide an incentive to producers to export is crucial to success.

and a few pages later she returns to the theme

“In particular, the exchange rate regime must provide an adequate return to producers of tradable goods, particularly to exporters”

At the time, this would have resonated strongly with senior New Zealand officials.  One of the starkest memories of my first year at the Reserve Bank, fresh out of university, was being minute secretary to a meeting in late 1984 attended by the top tiers of the Reserve Bank and The Treasury.  It was a just a few months after the big devaluation that ushered in the reform programme: senior officials were explicitly united in emphasising how vital it was to “bed-in” the lower exchange rate, and ensure that the real exchange rate stayed low.

You can see that 1984 devaluation in this chart of the real exchange rate I ran a few weeks ago.

ULC jun 18

In fact, the gains from the devaluation were swallowed up very quickly by inflation.    When we finally got on top of inflation, the real exchange rate did average lower for some time –  and during those years the tradables sector of the economy (and export and import shares) were growing relatively strongly.  But for the last 15 years, the real exchange rate has averaged even higher than it was prior to the start of the liberalisation programme.  It hasn’t been taken higher by a stellar productivity performance.

It shouldn’t be any surprise that the export and import shares of GDP have fallen back, and that there has been no growth at all in per capita tradables sector GDP this century.    Successful sustained catch-up growth –  of the sort New Zealand desperately needs – doesn’t come about that way.

Perhaps some attendee might ask Professor Krueger for any reflections on her 1985 comments about the importance of the real exchange rate in light of New Zealand’s disappointing economic experience since then.  And linking back to the topic of her 2018 lecture, can we now catch-up fast, having failed so badly to do for the last 30+ years?  Fixing the badly misaligned real exchange rate, a symptom of imbalances but which is skewing incentives all over the economy, seems likely to be imperative.  New Zealand just isn’t that different: wasn’t then, isn’t now.

 

 

Some more real exchange rates

A couple of recent posts have highlighted the really significant sustained increase in New Zealand’s real exchange rate.  I illustrated that with this chart

ULC jun 18

which shows the OECD’s relative unit labour costs measure.

Measures such as this, working back from a nominal exchange rate index, tend to be quite cyclical (around whatever longer-term trends are underway).  But there is another approach to the real exchange rate, an internal measure that looks at developments in the prices of non-tradables relative to the prices of tradables.    A rise in the ratio of those two sets of prices suggests, all else equal, that the tradables sector of the economy is becoming relatively less competitive.

Unfortunately, good long-term series of tradables and non-tradables prices are pretty few and far between.  The official series in New Zealand only date back to 1999 (and the Reserve Bank doesn’t publish the earlier versions that we calculated ourselves using highly disaggregated SNZ data).    Here is the chart of that measure of the real exchange rate, and the same derived series for Australia.

internal RER 1

To look at that chart, one might suppose that non-tradables almost always increased in price faster than tradables (although even at the start of the series –  when both countries’ nominal exchange rates were very weak –  there are hints otherwise).

Fortunately, Australia has these data back to 1982.

internal RER 2

For the first 20 years of the series it was fairly flat –  the difference between tradables and non-tradables inflation rates was only around 0.5 per cent per annum.   Since around 2001, the annual difference has been more like 2.5 per cent per annum.   Such differences have come to be taken for granted, but it isn’t a normal state of affairs.

Another way of getting a fix on the internal real exchange rate was suggested a few years ago by former Victoria University academic Geoff Bertram, in his chapter on the modern economy for the New Oxford History of New Zealand.  His measures calculates the real exchange rate as the ratio of the GDP deflator (prices of all the stuff produced in New Zealand) relative to the average of export and import prices.   Stuff that is exported is captured in both the numerator and the denominator, but all the non-tradables are in the numerator only, so that this measure will rise (fall) when non-tradables prices rise faster (slower) than tradables prices.   For New Zealand there are estimates of all the relevant deflators back to 1914.   Here is the resulting chart.

internal RER 3

For 70 years, there was no trend in the series. On average, over that full period tradables prices and non-tradables prices seem to have increased by about the same amount.  The cycles were quite prolonged, but no trend was apparent.   And then everything changed, and the sort of appreciation we’ve seen on this measure over the last 30 years is unlike anything seen before.

What about Australia?  Here is the same chart, going back to 1900.

internal RER 4

Much the same sort of picture –  a flat trend for 80 years, and then a sharp sustained move upwards (although not quite as large a move as that for New Zealand).

(It isn’t a universal pattern: the official US data go back to 1929, and although there has been an increase late in the period, the current level is not even 10 per cent above the previous peak.)

To be honest, I’m not sure quite what is going on in New Zealand and Australia, although the numbers would be consistent with both countries having experienced very weak productivity growth in their non-tradables sector (thus economywide cost increases spill into prices).  In New Zealand, weak productivity growth translated into weak overall economic performance, while in Australia the windfall of huge newly-tapped mineral resources has kept their overall economic performance looking better.  It is, after all, a real income gain.

Export volume growth in the last 30 years as a whole has outstripped the growth in real GDP in both countries, but that margin has been far larger in Australia than in New Zealand.  In Australia, export volume growth over that period was almost twice as fast as real GDP growth.

I noted that even on those internal real exchange rate measures, the increase in New Zealand has been larger than in Australia.     The same thing shows up, much more starkly, with a simple calculation of a New Zealand/Australia real exchange rate, taking the nominal exchange rate and adjusting for inflation differentials.    This chart shows that measure going back to 1914.

rer nzd aud

Again, a reasonably flat trend for 70 years, and then the move up to the new much higher level from the late 1980s.   And this, even though our productivity growth has continued to drift further behind Australia’s.

And for those keen to fall back on terms of trade stories, they don’t help.  This chart shows the terms of trade for New Zealand and for Australia back to the early 20th century.

TOT aus and NZ jun 18

Over 100 years, the two countries’ terms of trade have done much the same thing, ending up almost in an almost identical place.

So Australia was able to bring to market huge new mineral resources, and managed much faster productivity growth than New Zealand, and yet New Zealand has had much the larger real exchange rate appreciation.

Beginning to make inroads on New Zealand’s dismal productivity performance seems almost certain to require getting to the bottom of what has given rise to such an appreciation –  on almost any measure one cares to look at, internal or external.

(Meanwhile our bureaucrats avoid the real issues, while looking busy.  Yesterday I stumbled on this on an MBIE website, touting a new panel of experts –  half academics, a third public service economists –  to help fix businesses.

It’s common for small businesses in New Zealand to be passionate about what they do, but pressed for time. So working “on” the business instead of “in” the business often stays at the bottom of a long to-do list.

Business owners and operators tell us they would love to improve their systems and processes to get better results, and to save time and money. But getting these up and running takes time they just can’t spare.

This lack of time to work “on” the business is one reason why New Zealand’s productivity is comparatively poor. This poor productivity is a problem, whether you want happier workers, bigger profits or a better work/life balance — or a combination of these goals.

To help Kiwi businesses find practical ways to improve their performance, we’ve brought together a panel of experts from New Zealand and around the world, and combined their insights with our own research with small businesses.

I suspect small business owners are often rather busy whichever country they are operating in (high productivity or low), that we are better off assuming that private sector people make the best of their opportunities, and that the answers to the question of why New Zealand now lags so badly behind lie rather more with the politicians and their public service advisers than with the private sector.  Skew the playing field, and it is hard to get a good game.  Perhaps –  as in areas of financial conduct –  the (self-proclaimed) physicians should “heal themselves” (fix things they are directly responsible for) rather than touting their alleged skills in fixing private businesses.  Apart from anything else, there are professionals running their own businesses offering advisory services, and they actually face a market test.)

 

 

 

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.

OECD real ULC

(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

Notably:

  • 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.

SGD

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.

SGD and NZDAUD

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.

SGD NZD and KRW

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.