The New Zealand Dollar

2004/01 11 March 2004 The New Zealand Dollar Executive summary • The substantial appreciation of the New Zealand dollar since late 2000 is not histo...
Author: Frederica Logan
2 downloads 2 Views 519KB Size
2004/01 11 March 2004

The New Zealand Dollar Executive summary •

The substantial appreciation of the New Zealand dollar since late 2000 is not historically unprecedented. In the 1960s, the New Zealand dollar was fixed for several years at around US$1.40, but from the late 1960s until the mid 1980s it significantly depreciated in value due to New Zealand’s inflation exceeding that among our trading partners.



Since the New Zealand dollar was floated in 1985, it has tended to cycle between a range of US40 cents and US70 cents.



The real exchange rate can be useful for assessing New Zealand’s international price competitiveness.



There is evidence the New Zealand dollar is currently significantly overvalued, but projecting its future path is inherently difficult due to forecasting difficulties. Many economic commentators nevertheless believe the New Zealand dollar is either at, or near, the top of its latest exchange rate cycle.

Introduction

The strengthening New Zealand dollar has become a highly topical issue recently. The appreciation of the dollar against the currencies of our major trading partners has been substantial. On a trade-weighted basis, the New Zealand dollar has appreciated by 45 percent between November 2000 and February 2004. Against the US dollar, the appreciation has been even stronger, rising 73 percent over the same period. Put another way, in November 2000 one New Zealand dollar could only buy less than 40 US cents, whereas by February 2004 it could buy nearly 70 US cents.1 This background note examines historical trends in the New Zealand exchange rate and covers some key issues related to its movement.

1 These figures use monthly averages for the exchange rates; daily rates for the NZ dollar to US dollar conversion exceeded the 70 US cent mark on several occasions during February 2004.

Trends in the New Zealand exchange rate The long-term trend in the value of the New Zealand dollar against its US counterpart since the early 1960s is provided in Figure 1 below (with recent monthly movement plotted in the inset graph). This shows that, on a historical basis, the appreciation in the value of the New Zealand dollar since 2000 is not unprecedented. Specifically, two broad phases can be identified in Figure 1 regarding the long-term movement in the currency. Figure 1: New Zealand’s nominal exchange rate with the United States, 1960-2004 NZ$ 1:US$ 1.60 0.75 0.70

1.40

NZ$1:US$

0.65 0.60

1.20

0.55 0.50

1.00

Feb-03 Apr-03 Jun-03 Aug-03 Oct -03 Dec-03 Feb-04

0.80

0.60

US 70 cents mark

0.40

0.20

0.00 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Source: Reserve Bank of New Zealand.

1960s-1985

First, from the late 1960s until the mid-1980s, the New Zealand nominal exchange rate significantly declined in value from historically high levels, mainly reflecting New Zealand’s domestic inflation rate exceeding that of our major trading partners (see Figure 2).2 Over this period, New Zealand operated a fixed, but adjustable, exchange rate system. This meant that changes in the level of the New Zealand dollar (involving mostly devaluations in a bid to offset New Zealand’s high relative inflation, but including some revaluations) were dictated by the Government. The appendix of this paper provides more detail on key changes in the fixed exchange rate up until the mid-1980s.

2

Although Figure 1 tracks changes against the US dollar, a very similar trend is evident when looking at changes in the value of the NZ dollar on a trade-weighted basis.

2

Figure 2: Average annual inflation rates, 1965-85 (%) 0

2

4

6

8

10 10.2

New Zealand 9.6

United Kingdom 7.9

Australia Japan United States

12

6.6 6.1

Source: IMF, International Financial Statistics Yearbook.

1985-present

The second broad phase in the long-term movement of New Zealand’s nominal exchange rate coincides with the shift to a freely floating system in 1985. A floating exchange rate system means the rate is determined by supply and demand for the currency in the currency markets.3 New Zealand’s floating exchange rate is described as a ‘clean’ float, since the Reserve Bank of New Zealand has not intervened directly in currency markets to influence the balance of supply and demand of the New Zealand dollar.4 In contrast, a managed or ‘dirty’ floating exchange rate system is one where the central bank occasionally intervenes in the market, through the buying or selling of currency, in an attempt to alter the balance of supply and demand and thereby influence exchange rate levels.5 Japan operates an example of a managed floating exchange rate system since the Bank of Japan has regularly intervened in the markets to maintain the value of the yen. It should be noted, however, that the Reserve Bank of New Zealand also retains a right to intervene in the currency markets if it is deemed necessary in order to correct ‘disorderly’ market conditions—see Box 1.6 A key characteristic of New Zealand’s nominal exchange rate movements since the mid-1980s has been the replacement of a steadily declining rate with a cyclical movement in a range of around 40-50 US cents for troughs (in September 1986, February 1993, and November 2000) and around 70 US cents for peaks (in June 1988, November 1996 and currently). This reflects a substantial reduction in New Zealand’s domestic inflation rate from the mid-1980s and its closer tracking to the inflation rates in the economies of New Zealand’s main trading partners.7

3

Edwards and Holmes (1994), p.98. Conway and Franulovich (2002), p.2. 5 Edwards and Holmes (1994), p98. 6 Chatterjee and Birks (2001), p.312. 7 Hargreaves and White (1999), p.10. 4

3

Box 1: Reserve Bank intervention in the currency markets Although the Reserve Bank of New Zealand (RBNZ) has not directly intervened in the currency markets since the New Zealand dollar was floated in March 1985, it retains the right to do so. Section 16 of the Reserve Bank Act 1989 gives the Bank the power to intervene in the event of a “severe market breakdown or extreme market stress.”8 The RBNZ has given an example of disorderly conditions as: “market paralysis that might arise after a major political or financial crisis or a natural disaster.”9 Under the Act, the Finance Minister can instruct the Bank to intervene in markets to influence the rate, or even to fix it. The instruction must be in writing, given under the authority of an Order-in-Council, and be notified in the Gazette. However, the Reserve Bank has noted that these provisions were originally included in the Act when the floatation of the dollar had not been operating for long, and that such intervention could compromise the Bank’s ability to pursue its sole objective of monetary policy: maintaining price stability.10 Consequently, if the Bank Governor were to believe a directive to intervene in the currency markets was inconsistent with the price stability objective, he/she is able to not comply with the directive until the Finance Minister has formally invoked an override of the price stability objective under section 12 of the Act.11 This existing intervention policy is under review. The Reserve Bank announced on 11 March 2004 that it had provided advice to the Minister of Finance seeking greater capacity for the Bank to intervene in currency markets as part of its available monetary policy implementation tools.12 The Bank has recommended to the Minister that it have the capacity to intervene in the currency markets in situations other than when the markets have become disorderly. For example, the Reserve Bank (as of 11 March 2004) believes the New Zealand dollar is “exceptionally and unjustifiably high” and, consequently, that it should be able to use New Zealand dollars to buy foreign exchange in a bid to put downward pressure on the exchange rate.

New Zealand’s real exchange rate The trends in New Zealand’s exchange rate discussed in the previous section focused on the nominal (or current) exchange rate. A more useful indicator for analysing the effect of exchange rate movements, and also for assessing changes in price competitiveness of New Zealand’s traded goods and services with those of other countries, is the real exchange rate.

Removal of inflation’s impact

The real exchange rate is the nominal rate adjusted for prices in the New Zealand economy relative to prices in other countries. In other words, the real exchange rate strips out the effects of inflation. The real exchange rate can be expressed as a rate between two countries, for example the rate between New Zealand and the United States. More commonly, however, real exchange rates are given as ‘effective’ or trade-weighted rates. In the case of New Zealand, our real effective exchange rate adjusts for inflation the nominal exchange rate between New Zealand and our main trading partners. Figure 3a below compares New Zealand’s real and nominal effective exchange rates over the period 1980-2003, while Figure 3b tracks domestic inflation over the same period.

8

Reserve Bank (2001), Central Banking in New Zealand, October 2001, p.16. Reserve Bank (2003), This is the Reserve Bank, February 2003, p.9. 10 Reserve Bank (1999), Briefing on the Reserve Bank of New Zealand, November 1999, p.12. 11 ibid. 12 Reserve Bank (2004), News Release – Capacity to intervene in foreign exchange market proposed, 11 March 2004. 9

4

Figure 3a: New Zealand real and nominal effective exchange rates: 1980-2003 160 150 140

Real effective exchange rate (1995=100)

130 Nominal TWI (Jun 1995=100)

120 110 100 90 80 70 60

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Figure 3b: New Zealand’s inflation rate, 1980-2003 20% Co nsumer price inflatio n, annual quarter-o nquarter % change

15% 10% 5% 0% -5%

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: OECD, Main Economic Indicators.

This clearly shows that until the mid 1980s a steady decline in the value of New Zealand’s nominal exchange rate was driven by high inflation (with domestic inflation exceeding inflation rates overseas). In contrast, the real effective exchange rate remained relatively flat over the same period. A combination since the mid 1980s of reduction in the domestic inflation and its closer tracking to inflation rates among our main trading partners has meant the real exchange rate has closely tracked the cyclical movement of the nominal exchange rate in recent years.

The real exchange rate and New Zealand’s competitiveness An advantage of the real exchange rate is it takes account of how nominal exchange rates can move over time simply because of differences in inflation rates between countries.13 By removing this influence, the real effective exchange rate is a more useful measure than nominal rates of New Zealand’s international price competitiveness with other economies.

13

Hargreaves and White (1999), p.9

5

Purchasing power parity

The rationale behind the use of the real exchange rate as a measure of international competitiveness is an economic theory called purchasing power parity (PPP). This is an idea that the purchasing power of currencies will tend over time towards equality. The reasoning is as follows: if the same good is priced differently in different countries then international demand will eventually shift towards the good in the cheaper country. This increase in demand will boost demand for the cheaper country’s currency, causing it to appreciate in value. Consequently, the relative price of the good rises and demand will eventually shift to other countries. Over time then, the PPP theory suggests prices will equalise over countries. In practice, the movement of exchange rates is more complicated, and research testing the viability of the PPP theory has produced mixed results. Empirical research supporting the concept has tended to find it exists only after very long time periods, such as over decades.14 Over shorter time periods, there are a number of factors that influence exchange rates and cause deviations from long-run averages—these are discussed in the next section. Nevertheless, it has been noted by the Reserve Bank of New Zealand that a feature of the New Zealand real exchange rate is its “apparent tendency to settle back to a fairly stable long-term average.”15 This tendency is illustrated in Figure 4, which plots New Zealand’s real effective exchange rate since 1980 against its long-run average level over the past 30 years.

Figure 4: New Zealand’s real effective exchange rate and its long-run average 120 115

Real effective exchange rate (1995=100)

Im plied overvaluation

110 Declining c ompetitiv enes s

105 100 95 Improving competitiveness

90 85 80 75

Long-run average real exchange rate (1973-2003)

Im plied undervaluation

70 198 0 1981 19 82 198 3 198 4 198 5 19 86 19 87 198 8 19 89 19 90 199 1 1992 19 93 19 94 19 95 1996 1997 19 98 1999 20 00 200 1 20 02 20 03

Source: OECD, Main Economic Indicators.

14 15

Conway and Franoluvich (2002), p.3. Reserve Bank of New Zealand (2002), Monetary Policy Statement, August 2002, p.13.

6

Referring to Figure 4, decreases in the real exchange rate generally serve to act as a stimulatory influence on the economy.16 New Zealand’s international price competitiveness on its traded goods and services improves, since New Zealand prices fall relative to foreign prices when converted into foreign currency. Conversely, an increase in the real exchange rate implies it acts as a contracting influence on the economy since New Zealand’s price competitiveness with internationally traded goods and services slips with the stronger currency. It should be noted, however, that an appreciation of the real exchange rate is not entirely a net cost to the economy. For example, importers can gain from a rise in the exchange rate and this has flow-on effects to consumers of imported goods and firms that invest in imported capital equipment and inputs for their businesses.17 Additionally, it has been noted that the exchange rate has tended to act as a useful ‘buffer’ for reducing the impact of swings on international commodity prices.18 When high commodity prices make trading conditions for New Zealand’s still predominantly commodity-based exports favourable, the exchange rate has often tended to appreciate (sometimes with a time lag)— see Figure 5. Although this removes some of the gains to exporters, it also helps offset downward movements in commodity prices. (This relationship between commodity prices and the exchange rate broke down over the dot.com bubble period of 1999-2001, with high global demand for the US dollar dampening the value of the NZ dollar.19)

Figure 5: International commodity prices and the NZ exchange rate 140

75 70

130 65 120 60 110

55 50

100 45 90

ANZ w orld commodity price index (LHS) 40

NZ trade-w eighted index (RHS)

35 80 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: ANZ, Reserve Bank of New Zealand. 16 The point from which the exchange rate has moved is an important consideration. For example, if the exchange rate falls this will add to competitiveness but might still have a contractionary impact on the export sector if the level of the exchange rate is still higher than implied by economic fundamentals. 17 Reserve Bank of New Zealand (2003), Monetary Policy Statement, December 2003, p.6. 18 ibid; Westpac (2004), p.2. 19 Westpac (2004), p.2.

7

Overvaluation/undervaluation of the New Zealand dollar When New Zealand’s real effective exchange rate deviates from its long-run average (as shown earlier in Figure 4), this implies that the New Zealand dollar enters periods of undervaluation or overvaluation relative to the currencies of our main trading partners. The recent appreciation of the New Zealand dollar since late 2000, for example, has moved it into a range where many commentators believe the dollar is currently significantly overvalued.20 This has negative economic implications for the economy. Since New Zealand is a small, open and trade-dependent economy, it is able to sustain longer periods of undervaluation of its currency than periods of overvaluation.21

Measurement Measuring the precise degree of under- or overvaluation of the currency is problematic, however. Estimates of the long-run average exchange rate problems 22

differ according to the time period used for averaging. Calculating real exchange rates is also tricky due to problems measuring relative price levels across different countries. The most common measure of domestic inflation in economies is a consumer price index (CPI), but this covers many goods and services that are not traded internationally, whereas exchange rates refer to traded goods and services.23

Research undertaken by economists at the Reserve Bank of New Zealand have estimated New Zealand’s long-run equilibrium exchange rate with the United States (i.e. the rate at which there is purchasing power parity) at either 52 US cents or 60 US cents, depending on the estimation methodology used.24 The authors noted, however, that their results were “very sensitive” to the sample time period used for analysis. Westpac economists have estimated the long-run NZ/US bilateral exchange rate at nearly 56 US cents.25 Based on these estimates, the February 2004 average exchange rate of one New Zealand dollar buying 69.1 US cents was overvalued by between 15 and 33 percent—see Table 1 below. Table 1: Estimated overvaluation of the New Zealand dollar against the US dollar, Feb 2004 Comparison of estimates of long-run value of exchange rate against February 2004 average exchange rate Estimates of long-run equilibrium rate

US cents

Implied overvaluation of February 2004 average rate of 69.10 US cents

Brook and Hargreaves: Methodology 1

52

+32.9%

Methodology 2

60

+15.2%

Westpac estimate:

56

+23.4%

Source: Brook and Hargreaves (2001); Reserve Bank of New Zealand; Westpac (2004).

20 For example: BNZ (2004), BNZ Weekly Overview, 12 February, p6; The National Bank of New Zealand (2004), Financial Markets Update, January, p.6; Westpac (2004), p.2. 21 Westpac (2004), p.2. 22 For example, Figure 4 used a 30 year average. Reducing this to a 25 year average produces a different, but similar, result. 23 A general overview of the problems of measuring real exchange rates is contained in The Economist (1996), How cheap is a piece of string?, 20 January, p.83. For more technical coverage, see Reserve Bank of Australia (2001). 24 Brook and Hargreaves (2001), p.1. 25 Westpac (2004), p.2.

8

The outlook for the New Zealand dollar Forecasting difficulty

Exchange rate movements are notoriously difficult to forecast. The chairman of the US Federal Reserve, Alan Greenspan, has even remarked that: ”To my knowledge no model projecting movements in exchange rates is superior to tossing a coin.”26 The reason for this forecasting difficulty is that there are a multitude of influencing factors that can come in to play with driving the demand for a currency—see Box 2. The degree to which various factors influence currency demand is often unpredictable, largely due to the strong influence financial market “sentiment and momentum” can have on exchange rate movements.27 For example, over the ‘dot.com’ boom of 1999-2001, global investor sentiment and momentum was strongly skewed towards investing in the US dollar, while the New Zealand and Australian economies were viewed (somewhat erroneously) as commodity-based economies. Therefore, demand for their currencies was weak over this period despite other factors that normally support a strong currency existing, such as high interest rates in Australasia.

Box 2: Possible contributing factors to exchange rate movements A multitude of factors can influence demand for different currencies. For most of the following factors, the influence can be driven by both actual and expected developments: • • • • • • • • • • • • •

Relative economic performance Relative productivity Relative interest rates and their differentials (nominal and real) Returns on assets Current account balances Government fiscal balances International commodity prices Terms of trade Relative wage rates Laws/regulations/trade agreements/tariffs War/civil unrest Disaster Financial crises/panics

The degree of influence of factors can shift or even be overrode by other factors over different times. More economically ‘fundamental’ factors such as many of those listed above (e.g. productivity) can be influenced or even overrode by any of the following factors: • Investor sentiment • Trader momentum in financial markets • Investment fashion or fads Sources: Orr (1997); Reserve Bank of New Zealand (2002), Monetary Policy Statement, August; Westpac (2004).

26 27

Brittan, S (2004). Westpac (2004), p.2.

9

Despite the difficulty in projecting exchange rate movements, there has been a broad consensus among economic commentators that the recent period of appreciation in the New Zealand dollar has been driven mainly by a fall in value of the US dollar.28 More specifically, the US dollar has been undergoing a correction after a period of substantial overvaluation over the dot.com boom years of the late 1990s. The United States’ faltering economy and very large current account and government fiscal deficits have encouraged investors to sell out of US dollars in favour of other currencies, including the New Zealand dollar.29 Domestically, several factors have acted to support demand for the New Zealand dollar, including a relatively strong economy, improving commodity prices, and higher interest rates compared to other countries.30

Outlook over 2004

The outlook for the New Zealand dollar over 2004 is uncertain. Most economists expect the exchange rate to continue to be dominated by developments overseas in coming months, especially with the US economy and its currency. The New Zealand dollar is generally reckoned to be either at, or near, the top of its latest exchange rate cycle, but volatility in currency markets has made it difficult to suggest when the New Zealand dollar will start to trend down in value again.31 In its March 2004 Monetary Policy Statement, the Reserve Bank stated it assumed the trade-weighted index would remain around the level it had reached in early-2004 until the end of the year, before gradually easing back toward its long run average level.32 This prediction is made, however, on the basis of technical assumptions the Bank makes about the future movement of the exchange rate. Difficulties in forecasting exchange rates means the Bank does not forecast the trade-weighted index in a traditional sense.33

Antony Flux Economics and Industry Team Parliamentary Library For more information contact Parliamentary Library Ext. 9888 Email: [email protected]

28

e.g. ANZ (2003), ANZ New Zealand Market Focus, 11 December; Bank of New Zealand (2004), Weekly Overview, 12 February; Westpac (2004). 29 ibid. 30 Westpac (2004). 31 ANZ (2004), ANZ New Zealand Market Focus, 27 February; Bank of New Zealand/National Australia Bank, Economic Monitor, 18 February 2004. 32 Reserve Bank of New Zealand (2004), Monetary Policy Statement, March 2004, p.22. 33 Reserve Bank of New Zealand (2003), Monetary Policy Statement, December 2003, p.26.

10

References Brittan, S (2004), The dollar needs benign neglect, in the Financial Times, 29 January. Brook, A, Collins, S and Smith, C (1998), The 1991-97 business cycle in review, in Reserve Bank Bulletin, Vol.61, No.4, pp.269-290. Brook, A and Hargreaves, D (2001), PPP-based analysis of New Zealand’s equilibrium exchange rate, Reserve Bank of New Zealand Discussion Paper Series, DP2001/01. Conway, P and Franulovich (2002), Explaining the NZ-Australian exchange rate, Westpac Institutional Bank occasional paper, April 2002. Dalziel, P and Lattimore, R (1991), A Briefing on the New Zealand Macroeconomy 1960-1990. Dalziel, P and Lattimore, R (1999), The New Zealand Macroeconomy, A Briefing on the Reforms, 3rd edition. Edwards, S and Holmes, F (1994), CER: Economic Trends and Linkages. Hargreaves, D and White, B (1999), Measures of New Zealand’s effective exchange rate, in Reserve Bank of New Zealand Bulletin, Vol.62, No.3, September. Milne, D and Savage, J [eds] (1999), Reporting Economics – A NZ guide to covering the economy Orr, A (1997), Can’t blame it all on soaring Kiwi, in The Dominion, 4 March 1997. Reserve Bank of Australia (2001), Measuring the Real Exchange Rate, in Reserve Bank Bulletin, November, pp.70-73. (Available online: www.rba.gov.au/PublicationsAndResearch/ Bulletin/bu_nov01/bu_1101_2.pdf ). Reserve Bank of New Zealand (1986), Financial Policy Reform. Reserve Bank of New Zealand (Various dates), Monetary Policy Statement. Savage, J (1996), The Exchange Rate and Macroeconomic Management in New Zealand, NZ Institute of Economic Research Working Paper 96/28. Treasury (2002), New Zealand Economic and Financial Overview. Treasury (2003), Treasury Report: Exchange Rate Developments and Implications, http://www.treasury.govt.nz/exchangerate/default.asp Westpac (2004), A soaring kiwi, in Economic Overview, a quarterly overview of the New Zealand economy, January 2004.

Copyright  NZ Parliamentary Library Except for educational purposes permitted under the Copyright Act 1994, no part of this document may be reproduced or transmitted in any form or by any means, including information storage and retrieval systems, other than by Members of Parliament in the course of their official duties, without the consent of the Parliamentary Librarian, Parliament Buildings, Wellington, New Zealand.

11

Appendix: A summary of key movements in the New Zealand exchange rate (1934-1985) 1934-1961

In 1934 New Zealand’s exchange rate was set against the British pound sterling with the establishment of 34 the Reserve Bank of New Zealand. Between 1934 and 1938 there was unrestricted convertibility, but after 1938 the demand for pounds increased, resulting in the imposition of substantial foreign currency controls.35

1961

The formal linking of the New Zealand currency to the British pound lasted until 1961 when New Zealand joined the International Monetary Fund (IMF). A condition of joining the IMF was New Zealand had to establish a par value for the New Zealand in terms of the US dollar (and hence also in terms of gold). Despite this linking to the US dollar, changes in the rate after 1961 were effectively driven by shifts relative to the British pound and Australian dollar due to the importance of New Zealand’s trade relations with these currencies’ economies. The par value proposed by New Zealand when it joined the IMF was NZ £1 to US$2.27809.

1960s

During the 1960s, New Zealand’s nominal exchange rate remained unchanged until November 1967, when the Minister of Finance devalued the currency by 19.45%.36 This brought the New Zealand currency to parity with the Australian dollar and was an opportunity taken after the British pound was devalued against the US dollar.37

1967early 1970s

The exchange rate was unaltered until 1971, when restructuring of the world monetary system was introduced. In December 1971 a temporary international regime known as the Smithsonian Agreement was established in reaction to a number of currency crises overseas in the late 1960s. The aim of the Smithsonian Agreement was to increase stability of exchange rates. An impact of the agreement for New Zealand was the country opted to maintain its existing par value with the US dollar chosen as an “intervention currency.” This meant that the US dollar was the currency that New Zealand would stand ready to trade in order to meet its exchange rate obligations under the Smithsonian 38 Agreement. The Agreement failed to remove exchange rate pressures and a float of the British pound sterling and several other major currencies in 1972 (but excluding the US dollar) resulted in strong nominal appreciation of the New Zealand dollar.

1973-75

In February 1973 the US dollar was devalued by ten percent, resulting also in an increase in the price of 39 gold. New Zealand’s par value shifted to NZ$1 to US$1.1952. Over the rest of 1973, the value of the New Zealand dollar was reinforced by revaluations by the Minister of Finance in both July and September. These revaluations were made in reaction to rising terms of trade and a small balance of 40 payments surplus. These revaluations were effectively reversed in 1974 and 1975 by devaluations made in reaction to 41 economic repercussions (including a record balance of payments deficit) from the first oil shock.

1979early 1980s

In June 1979 a “crawling peg” approach to exchange rate determination was established. Under this system the New Zealand dollar was adjusted by small amounts (sometimes on a daily basis), with the aim of offsetting inflation rate differentials between New Zealand and its main trading partners. This caused a depreciation of New Zealand of around six percent per year between 1979 and the early 1980s.42 Between 1979 and 1983 the nominal exchange rate fell 23 percent, although it is important to note that the presence of high inflation meant the real exchange rate was hardly affected. In June 1982 the then-Government imposed a wage and price freeze, which pegged New Zealand’s dollar on a trade-weighted basis. By the second half of 1984 (after a snap election had been called) a foreign exchange crisis was created since demand for foreign exchange exceeded supply as exporters and 43 importers predicted the Government would be forced to substantially devalue the dollar. The Reserve Bank had to try and meet the excess demand by drawing down its foreign exchange reserves, resulting in the crisis. The exchange rate was devalued by 20 percent in July 1984 immediately following the election and the formation of a new government.

1985

The New Zealand dollar was fully floated in March 1985 and since then the Reserve Bank has not directly intervened in the foreign exchange markets.

34

Reserve Bank of New Zealand (1986), p.128. Savage (1996), p.1 36 Dalziel et al (1999). 37 Reserve Bank of New Zealand (1986), p129. 38 Reserve Bank of New Zealand (1986), p129. 39 Savage (1996). 40 Dalziel (1991), p.27. 41 ibid. 42 Reserve Bank of New Zealand (1986) and Savage (1996). 43 Dalziel (1991,1999). 35

12