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Capacity to intervene in foreign exchange market

Capacity to intervene in foreign exchange market proposed

The Reserve Bank has provided advice to the Minister of Finance recommending that, as one of its monetary policy implementation tools, it should have the capacity to intervene in the foreign exchange market to influence the level of the exchange rate.

The Reserve Bank’s current stance is to use its foreign exchange reserves to intervene only if the foreign exchange market became “disorderly”.

Reserve Bank Governor Alan Bollard said “We have recommended that when the New Zealand dollar is exceptionally and unjustifiably high, the Reserve Bank would be able to use New Zealand dollars to buy foreign exchange, which would put downward pressure on the exchange rate. And, when the exchange rate is exceptionally and unjustifiably low, we would be able to sell foreign exchange to buy New Zealand dollars, putting upwards pressure on the exchange rate. By unjustifiable, we mean when the exchange rate has moved to a level in excess of that readily explained by the relevant economic fundamentals, which occurs only infrequently. This process is similar to that used for some years by the Reserve Bank of Australia.

“By having this intervention tool, we would generally aim to influence the exchange rate in a direction consistent with maintaining our price stability goal. The addition of intervention as an instrument of monetary policy would also better enable the Bank to meet its Policy Targets Agreement clause 4B commitment, which stipulates that “In pursuing its price stability objective, the Bank … shall seek to avoid unnecessary instability in output, interest rates and the exchange rate.” That is, at extreme levels of the exchange rate, intervention may be chosen to supplement monetary policy.

“Importantly, such foreign exchange intervention would not be trying to permanently change the long-run exchange rate. And, the New Zealand dollar exchange rate cycle would not be eliminated. At best, we can influence the exchange rate only by small amounts at the extremes of its cycle when it is a long way from economic fundamentals. In doing this there could be financial risks to the Bank, requiring very careful management.

“In recent days we have put these ideas to the Minister of Finance. There is more work and consultation to be done before final decisions can be made or the setting of operational procedures and capacities,” Dr Bollard concluded.

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