The recent job summit called by Engineering, Printing and Manufacturing Union (EPMU) focused on the strength of the NZ dollar and the impact it is having on manufacturing jobs in the New Zealand economy. This has been area that the opposition parties have targeted especially the Greens. Although a weaker dollar would make exports more competitive there are concerns about the mechanism used to achieve. Certain procedures to reduce the value of a currency have been well documented. They are as follows:
1. Quantitive Easing – printing money.
You need to look no further than the US economy to to see what has been the impact of 3 rounds of QE. Although the US dollar fell after QE1 in late 2008 a lot of could be said to have been caused by the collapse of Lehman Brothers and others around that time. QE2 in November 2010 correlated with the fall in the US dollar but again some have indicated that this was a result of the US economy being energised by the Federal Reserve and therefore it was safe to buy risky investments (US dollar seen as safe). You don’t have to look for another example where QE has had a limited impact – Japan since 2001. Here the Japanese authorities have found that QE has seen the Yen strengthen.
2. RBNZ enter the foreign exchange market and buy NZ dollars with currency reserves
This has been tried before with little success – equilibrium is restored at pre-intervention levels and the venture has proved very costly. Furthermore, there is the specter of inflation to contend with in years to come. The currency value has been more influenced by which stage of the business cycle the NZ economy is sitting at. In the 1990’s the Bank of Japan has spent billions of dollars trying to stop the appreciation of the Yen against the US dollar. The Swiss National Bank had to spend the equivalent to 70% of its GDP buying euros to cap the Swiss franc.
3. Drop the Reserve Bank’s Official Cash Rate (OCR)
When an economy’s interest rates are relatively high compared to other economies there is the incentive to park your currency where you get higher returns i.e. borrow from Japan at near 0% and investing in Australia at 5%. However lower interest rates doesn’t necessarily mean a lower exchange rate – the Reserve Bank of Australia has dropped rates from 4.75% to 3.25% over the last couple of years but the Aussie dollar hasn’t moved. This is most likely due to the mining boom.
4. Contractionary Fiscal Policy
As Don Brash (Former RBNZ Governor) stated in the NZ Herald, the best way of reducing the value of the NZ dollar would be for the government returning to a surplus by reducing government spending and increasing taxes. This would take money out of the circular flow and therefore reduce aggregate demand. With inflation nearing the bottom of the target range the RBNZ would be forced to reduce the OCR and ultimately the NZ dollar without the threat of inflation.
Getting the exchange rate down is a very complex task and it seems that the foreign exchange market doesn’t punish negative figures of economic indicators i.e. high inflation. I suppose a increase in the value of the NZ dollar is due to our desire to fund our spending from overseas borrowing.