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.



Some snippets from the annual trade data, with a China tinge

Statistics New Zealand released yesterday the annual data on New Zealand’s overall foreign trade (goods and services) by country.  It is a nice summary set of tables for people who don’t spend lots of time looking at trade data, and the services data are only available annually.

Since the end of last year, these have also been the data the Reserve Bank now uses to calculate the weights in its trade-weighted index measure of the exchange rate.  Those weights are calculated on a total trade basis (imports and exports, goods and services) for 17 currencies, covering countries that currently account for a bit over 80 per cent of New Zealand’s foreign trade.  The weights are updated annually, and when they are updated in December there will be a few changes.  After much noise about China becoming our largest trading partner (which it has not yet been on a total trade, or even total exports, basis), China’s share in New Zealand’s foreign trade dropped back quite a bit over the last year.  By contrast, the United States’ share rose.  Whereas this year, the weight on the Australian dollar was only 2 percentage points more than that on the Chinese yuan, both well ahead of the US dollar, next year the weight on the yuan will be around halfway between those on the Australian and US dollars.

twi weights

There is no easy right answer as to how to weight an exchange rate index.  My own sense is that the current weighting structures overstates the importance of Australia, and understates the importance of the United States and the euro area (or the EU more broadly).  These latter two economies/regions are a huge share of total world production/consumption, and are major competitors in our largest (net) export products, particularly dairy.  Neither element is captured in the current weighting scheme.  And while Australia is our largest export market, those numbers are flattered by the fact that still more than 12 per cent of our exports to Australia are crude oil and precious metals (presumably mostly newly-mined gold), which have nothing to do with wider economic conditions in Australia, or movements in the Australian dollar.

It is interesting how much of our trade with Australia is now dominated by travel.  Excluding oil and precious metals, 28 per cent of our exports to Australia are travel and transport.  No other single category exceeded 7 per cent of our exports to Australia last year.   The picture is similar on the import side, where travel and transportation account for 27 per cent of our Australian imports.

And, finally, I was interested in the dairy export data.  The media has been full of discussions around dairy exports to China, which had surged in 2013/14.

Here are our milk powder, butter and cheese exports for the last five years to China on the one hand, and the ASEAN countries on the other.

dairy exports china and asean

It highlights both how unusual last year was, but also how important those other countries are in New Zealand’s dairy trade.   In a typical year, New Zealand firms export as much milk powder, butter and cheese to these countries as to China, and yet these countries in total have annual GDP not much more than 20 per cent of China’s.  Actually, the data also illustrate just how diversified dairy exports are in a typical year.

dairy exports 2014 15

By contrast, in the 1950s almost all our dairy exports went to the United Kingdom, and there were few other export markets anywhere for dairy products.

None of this is to suggest that China is unimportant.  China is now the world’s second largest economy, with a very large foreign trade for a country of its size.  And is a badly-managed, highly non-transparent, economy, at the tail end of one of the bigger, least-disciplined, credit booms in history.  What happens in China matters a great deal to most countries, but there is no reason to think it matters abnormally more to New Zealand.

(As one perspective on the lack of transparency –  and, worse, outright misrepresentation –  that plagues the rest of world making sense of China, I’d recommend the latest from Christopher Balding, who takes on those who want to defend China’s data as providing a broadly accurate and representative picture of what has been going on).

Putting the exchange rate fall in historical context

New Zealand’s exchange rate has fallen quite a way in the last few months. The fall was most dramatic from late April to the start of July, when the Reserve Bank’s TWI measure fell from just over 80 to just over 70, a fall of around 12 per cent. Using monthly average data the fall from April to July was almost as large as any three-month fall we’ve seen in the 30 years New Zealand’s exchange rate has been floating.

twi 3 month changes

But sharp as that fall has been, the total fall in the TWI so far still looks only moderate by the standards of past corrections in the New Zealand dollar. In this chart, I’ve gone back a bit further. The new Reserve Bank TWI data only go back to the start of 1984 at present, but using the BIS indices we can go back another 20 years, to give us just 50 years of data.

TWI largest falls

The first three adjustments were discretionary devaluations, two (1967 and 1975) in response to sharp falls in the terms of trade, and the last associated with the change of government in 1984. As I noted a couple of weeks ago, the fall in the exchange rate so far is similar in magnitude to the short-lived sharp fall in the first half of 2006, when a “growth pause” (still showing in the data as no real GDP growth from 2005Q2 to 2005Q4) sparked expectations of forthcoming cuts in the OCR.

Graeme Wheeler has been using the slightly odd terminology that the exchange rate “needs” to come down and I have already commented earlier on that.  He seems to have in mind some sense of an exchange rate which would stabilise the ratio of NIIP/GDP.  But it is not entirely clear why he thinks the exchange rate is likely to actually fall further. After all, he has been openly disagreeing with market commentators who think the OCR might need to fall to 2 per cent, suggesting that he doesn’t see that the need for the OCR to fall much further. Recall that the falls in the OCR he seems to be envisaging will be tiny when compared to previous policy rate cycles here and abroad. His story seems to envisage that perhaps last year’s OCR increases will be fully reversed, but no more –   but previous easing cycles have involved multiple hundreds of basis points moves.  And, on the Governor’s rather upbeat story, we might reasonably expect the negative NIIP position to widen, to act as the buffer for some of the loss of national income, over the next year or two.

niip to gdp

After all, in the last few years, the NIIP/GDP position has been less negative than it had been for most of the last 25 years (through some combination of the offshore insurance claims resulting from the earthquakes, not yet fully spent, and the high terms of trade). On his story why should we expect much more? If he is right about New Zealand’s monetary policy outlook, many in the market will be surprised and, if anything, the TWI might rise.

But I’m sceptical of the Governor’s story about the New Zealand economy and prospects for domestic monetary policy. When I filled in the Bank’s Survey of Expectations last week, I wrote down a prediction that implies an OCR below 2 per cent by this time next year, and I wondered afterwards if my number was low enough yet. I don’t think anything that weak is yet priced into the central market view. If so, most likely the TWI will move quite a bit lower yet.   Heightened periods of risk are also often bad for New Zealand’s exchange rate –  no one has to hold New Zealand dollar assets when times are risky –  and markets still seem remarkably relaxed about China and the euro-area as sources of economic and financial risk.

Finally, recall that the TWI fell to the lowest level in the last quarter century in 2000, the last (and only) time since liberalisation when US short-term interest rates matched those in New Zealand.  At the 2000 trough, the TWI was some 30 per cent lower than it is today.

The exchange rate “needs” to come down?

I’ve been continuing to reflect on Graeme Wheeler’s repeated observation that New Zealand’s exchange rate “needs” to come down. I’m still not entirely sure what he means. The exchange rate is an asset price and presumably should reflect all expected future relevant information, not just spot information about current dairy prices. And the market has no particular reason to focus on stabilising the net international investment position at around current levels. Indeed, although it is a convenient reference point, neither does the Reserve Bank.

“Need” or not, I’d have thought it was likely that the exchange rate would fall further.

The ANZ Commodity Price Index, which lags behind (for example) falling GDT and futures dairy prices, has already had one of the larger falls in the history of the series.

ANZ Commodity

Meanwhile, the fall in the exchange rate, while material, remains pretty small by the standards of past New Zealand adjustments since the float in 1985. At the moment, the adjustment is comparable to what we saw in the shortlived growth (and risk) scare in 2006.

And here are the BIS real exchange rates for the five OECD commodity exporting countries, and South Africa. Each has experienced rather different commodity price pressures and opportunities. Here the exchange rates are each based to 100 at the average for each country in the year to June 2008 just prior to the global recession and crisis.

bis exch rates

New Zealand’s exchange rate doesn’t stand out dramatically, but it remains higher, relative to pre-recession levels, than in these other countries. In part that is likely to reflect yield differentials. New Zealand is the only one of these six countries still to have policy interest rates higher than they were 18 months ago. That is Graeme Wheeler’s choice, and while data may eventually force him to change his view, it is his view that for now determines short-term interest rates on offer in New Zealand

Productivity growth worse than in Greece

In the interview with Richard Harman I noted that one of my main interests and (rather more importantly) one of the bigger challenges for New Zealand was its disappointing economic performance over the last 25 years.    The liberalisation of the economy in the 1980s and early 1990s was generally expected to have reversed the earlier decades of relative decline.  Not everyone shared that optimism, but among the advocates of reform within government and the public service, and among most international observers (for example, the IMF and OECD, and financial markets), that sort of re-convergence was generally expected.

But it didn’t happen.  For a while there was a “the cheque is in the mail” hypothesis doing the rounds –  it hadn’t happened yet, but it surely wasn’t far away.   But 25 years is a long time, and it just has not happened.  Around 1990, the former eastern-bloc countries started serious liberalisation.  Their economies had been much more heavily distorted than New Zealand’s (notwithstanding the Bob Jones crack in 1984 about the New Zealand economy resembling a Polish shipyard), but they have subsequently seen considerable convergence.

Here is my favourite summary chart of our underperformance over that period.  Using the Conference Board data, it is total growth in real GDP per hour worked for 42 advanced countries (OECD, EU, and Singapore and Taiwan) since 1990.  Only five countries had had slower growth over that period than New Zealand –  and two of them (Switzerland and the Netherlands) had had among the highest levels of labour productivity in any of these countries in 1990 (so one might have expected unspectacular growth subsequently).  No cross-country comparative measure is perfect, but I don’t this one is particularly unrepresentative of New Zealand’s relative performance  On this measure, Greece and Portugal have done less badly than us  (but recall that this is GDP per hour worked, and in the current Greek Depression total hours worked have dropped away precipitously).

GDPphw since 1990

I’ve been running a story about the role of immigration policy in explaining that failure to converge –  total GDP has grown a lot, even if GDP per hour worked hasn’t.  In this wider sample of countries, New Zealand has had among the faster rates of population growth, despite the huge outflow of New Zealanders (around 525,000)  over that period.   Singapore (86%) and Israel (77%) have had much faster rates of population growth than New Zealand (30%) over this period.

My argument has been that in a country with a low savings rate, rapid population growth has put considerable sustained upward pressure on real interest rates and the real exchange rate, squeezing the share of GDP devoted to business investment and preventing the emergence of new tradables sector firms/products at the rate that (a) convergence would have required, and (b) the rest of NZ’s microeconomic policy framework might have suggested/warranted.  A few weeks ago, I showed how our real exchange rate against Australia had failed to decline despite the deterioration in our relative economic performance over decades.

Here is another way of looking at the same point.  The two countries with the fastest growth in the chart above were Taiwan and Korea.  Singapore has also done impressively well.  In 1990, Taiwan and Korea were well behind New Zealand, and Singapore had about the same level of real GDP per hour worked as New Zealand  (precise comparisons depend on which set of relative prices are used, but on any measure all three countries have had growth outstripping that of New Zealand).

And here is the picture over 50 years, again using the Conference Board data
gdpphw asia
All three Asian countries have had some of the more dramatic catch-ups in productivity levels seen anywhere.  New Zealand, by contrast, in 1965 was among the advanced countries with the highest levels of labour productivity, and has been in relative decline since.

But what has happened to the countries’ real exchange rates since?  As ever, there is no unambiguous way to measure that, but the BIS have real exchange rate indexes for each of the four countries going back to the 1960s.  Of course, real exchange rates can move around a lot from year to year, so in this chart I’ve shown the percentage change in the real exchange rate from the average for 1966-70[1] to the average for the 10 years to May 2015.

bis rer asia

The countries that have had such dramatic productivity improvements have all recorded modest falls in their real exchange rates, and by contrast New Zealand has had an increase in its real exchange rate.  That is opposite of what one might initially have expected.  One might have expected a strong real appreciation in the Asian currencies (as has happened in Japan), as much higher incomes supported more and cheaper consumption in these countries.  Fewer resources now needed to be devoted to the tradables sectors in those countries.   And in New Zealand one might have expected the deteriorating productivity performance, and hence declining (relative) future consumption opportunities, to have been met by a declining real exchange rate. That would have increased the returns to productive investment in New Zealand –  helping to reverse the decline – and raised the relative price of consumption.

How does my story explain what went on?

In last 25 years, Korea and Taiwan have had materially slower population growth rates than New Zealand has, and much higher savings rates.  That meant both less pressure on resources simply to maintain the capital stock per person, and more domestic resources available to meet investment demand.  The net result: little upward pressure on real interest rates and the real exchange rate, despite the continuing productivity gains.

Singapore is at the extreme.  The national savings rate has averaged 46 per cent in Singapore over the last 25 years, roughly double the rate for advanced countries as a whole.  With so many resources available (earned but not consumed) even the investment needs of an average population growth rate of 2.5 per cent puts no pressure on domestic resources, or hence on real interest rates and the real exchange rate, despite the continuing productivity gains.

And that is my story in a nutshell: with very high saving rates your country might need lots more people to make the most of the savings.  But in a country with only a rather modest savings rate (for whatever reason) then having lots more people –  and especially bringing them in as a matter of policy – simply looks wrongheaded.  It undermines what policy is setting out to achieve.

It isn’t that migrants somehow “take away jobs”, but rather that rapid population growth (whether migrants or high birth rates) tends to divert resources (jobs) away from growing the bits of the economy that sell to the rest of world (a huge and diverse market, and probably where our future prosperity is to be found) to ensuring that the physical infrastructure (houses, roads, shops, factories, schools) keeps pace with the needs of the growing population. It makes it very hard to catch up with the richer countries.   Israel has found something much the same.

No comparison of any pairs of countries, in any particular period, is ever going to be conclusive.  I use the examples in this post simply to illustrate the story.

[1] Starting the comparison from the start of the BIS series in 1964 would result in an even larger fall for Korea

China: the composition of the RB TWI really doesn’t matter for monetary policy

The BNZ’s Raiko Shareef has a research note out looking at the impact of including the Chinese yuan in the Reserve Bank’s trade-weighted index measure of the exchange rate. He argues that the inclusion of the CNY will increase the sensitivity of New Zealand’s monetary policy to developments in China.

I think he is incorrect about that. China has, of course, become a much more important share of the world economy in the last couple of decades. It has also become a much more important trading partner for New Zealand. Both of those developments, but particularly the former, mean that economic developments in China, including changes in the value of China’s currency, have more important implications for New Zealand, and other countries, than they would have done earlier. The Reserve Bank recognised the importance of the rise of China in setting monetary policy, and assessing developments in the exchange rate. But the Bank was quite slow to include the CNY in the official TWI measure. There was a variety of reasons for that, some more persuasive than others. But as far back as 2007 the Bank started publishing supplementary indices that included the CNY. If the Reserve Bank had used the old TWI in some mechanical way, then perhaps it would have been misled, and perhaps there would have been policy implications from the change in weighting schemes, But not even in the brief bad old days of the Monetary Conditions Index was the TWI used mechanically for more than a few weeks at a time. Every forecast round, the Bank comes back and goes through all the data, not just a reduced-form equation feeding off a particular TWI.

In the new TWI, the CNY has the second largest weight (20 per cent), just behind that on the Australian dollar.(22 per cent). But for the time being, that is likely to be high tide mark for the weight on China’s currency. Here is what has happened to goods trade – imports from China have kept on rising, but export values have plummeted (mostly on the fall in dairy prices).

A bigger question is one about what the appropriate weight on the CNY (and other currencies) is. I’ve argued that the CNY is important to New Zealand not because in a particular year we happen to sell lots of milk powder there, rather than in some other market, but because China is a large chunk of the world economy.  If we had no direct trade with China, it would still matter quite a bit.  In that sense, I reckon the new TWI understates the economic importance of the USD and the EUR, and overstates the importance of the AUD. We trade a lot with Australia, but Australia has very little impact on the overall external trading conditions our tradables sector producers face.

There are no easy answers to these issues. In a sense, that was why the Bank settled last year on a simple trade-weighted index. It wasn’t necessarily “right”, it wasn’t what everyone else did, but it was easy to compile and easy for outside users to comprehend. And without spending a huge amount of resources, on what was (probably appropriately) not a strategic priority, it wasn’t clear that any more sophisticated index would provide a better steer on the overall competitiveness of the New Zealand economy.

An issue of the Bulletin, written by Daan Steenkamp, covered some of this ground last December.

As already discussed, the new TWI has appreciated much less than the old TWI over the past decade or so. It is natural to ask whether the difference has, or should, affect how the Reserve Bank interprets or assesses the exchange rate. For example, are recent judgements about the ‘unsustainability’ of the exchange rate around recent levels affected? The exchange rate, however measured, is never considered in isolation from everything else that is going on in the economy. The Reserve Bank has, for example, recognised the rising importance of Asia in New Zealand’s trade and has taken that into account in its analysis and forecasting over the past decade or more. Exporters and importers deal with individual bilateral exchange rates, not summary indices. And New Zealand’s longstanding economic imbalances have built up with the actual bilateral exchange rates that firms and households have faced over time. How those individual bilateral exchange rates are weighted into a summary index therefore does not materially alter the Reserve Bank’s assessments around competitiveness and sustainability. Applying the macro-balance model (Steenkamp and Graham 2012) or the indicator model of the exchange rate (McDonald 2012) to the new TWI there are inevitably some changes, but the conclusions of those models, about how much of the exchange rate fluctuations are warranted or explainable over the past decade or so, are not materially altered.

There is no single ideal measure of an effective exchange rate index. Different TWI measures are useful for different purposes. In trying to understand changes in competitiveness it is likely to be prudent to keep an eye on them all. Developments in specific bilateral exchange rates will also have different relationships with economic variables and will be useful for different types of analysis. The focus of the Reserve Bank’s approach is on assessing the impact of the exchange rate on the competitiveness of New Zealand’s international trade, and the implications for future inflation pressures. Developing a full indicator of competitiveness, that reflected the specific nature of New Zealand’s international trade, and in particular the importance of commodity markets would require a very substantial research programme. It is difficult to be confident that the results would offer a materially better summary exchange rate measure than the simpler approaches the Reserve Bank has customarily adopted.

Of course, if China continues to grow in significance in the world economy, and if its currency becomes more convertible and is floated, it will become increasingly important to New Zealand. At the moment, the risks around China look somewhat the other way round – the influence of China may be more about the nasty aftermath of one of the biggest, least-disciplined credit booms in history. Growth looks to have fallen away much more than many (including the Reserve Bank) seem to have yet recognised.  But whatever the correct China story, the influence on New Zealand has little or nothing to do with how the Reserve Bank’s trade-weighted index is constructed.