>
Exporters warned; ‘Don’t put faith in policy promises
Monday, 06 August 2007

In this column last month we warned exporters not to get optimistic about the Reserve Bank’s intervention causing any decent decline in the Kiwi dollar.

That statement has been proved accurate with the Kiwi dollar at the time of writing sitting only just below the US 80 cent level and the Reserve Bank having done little extra intervention. In fact what they have done is redefine the terms of their intervention.

When they first intervened on June 11 they said it was in response to the Kiwi dollar trading at an excessively high level.

Now they have introduced a new set of rules along the lines of when the Kiwi dollar looks very high they will sell it and when it looks very low they will buy it back and make a little profit long way.

We read this as a massive backing away from allowing anyone in the market to interpret their intervention as directly aimed at in fact getting the Kiwi dollar down.

Instead they have introduced a policy along the lines of what the Reserve Bank of Australia has involving smoothing the currency fluctuations.

Ultimately they will in fact have very little impact on the currency and it is to the fundamentals one must look to get an idea about where the exchange rate is going to go and we covered these in spades last time around.

This month our warning to exporters is along the lines of not thinking that any of the ridiculous ideas we have seen recently about policy changes will actually come to fruition.

The first thing to ignore is a comment from the Minister of Finance suggesting that he may use his legislated powers to force the Reserve Bank to stop targeting low inflation. There is zero chance of this happening.

The Minister of Finance is well aware that New Zealand slid down the OECD relative income per capita table when high inflation prevailed in New Zealand over the 1970s and into the 1980s.

His comments were merely aimed at trying to scare a few overseas investors away from taking positions on the Kiwi dollar and given that the Kiwi dollar has continued to go upward he has not had success in this area. He probably never seriously expected to.

The other wasted discussion has been with regards to the Reserve Bank not raising interest rates but instead cutting them.

This is so ridiculous it defies belief and reflects very poorly on the people making the suggestion. It is true that if you cut interest rates the exchange rate will fall.

But what you will also get is a massive boom bust cycle in the housing market and severe damage to the economy.

Lower interest rates would cause people to borrow more money pushing house prices higher and pricing more first home buyers out of the housing market.

The extra debt driven growth in the economy will generally place more pressure on the country’s resources causing the overall inflation rate to rise which for businesses will mean greater growth in local authority rates, electricity charges, wages, and raw materials prices whether these materials are imported or produced domestically.

Business margins would be squeezed and all that would be achieved would be a transfer of wealth from most people in the economy to some favoured exporters.

The third ridiculous idea is that the Reserve Bank should be made to target not only inflation but also strong economic growth and some politician’s idea of that what an acceptable exchange rate would be.

It is impossible to use monetary policy to achieve more than one objective and history shows that objective is best left at low inflation.

Using monetary policy to achieve goals other than low inflation inevitably results in a reduction in one’s long-term potential growth rate.

Our advice to exporters remains the same as ever.

Be prepared for the New Zealand dollar to remain at high levels for a potentially long period of time in light of high interest rates, depreciation of the US dollar, and booming export commodity prices.

There will be pain and this is extremely unfortunate. But until the Reserve Bank does its job properly and crunches the domestic economy with a sharp increase in interestrates this pain will continue.

The best thing for all would be if the Reserve Bank pushed interest rates up in 0.5 per cent increments to control domestically generated inflation quickly.

They should have done this over 2004 and 2005 and the exchange rate would probably be 10 cents lower than it is at the moment.

• Tony Alexander is chief economist at the Bank of New Zealand.