Challenges for small open economies in uncertainty

Reserve Bank Email Service

FYI the RBNZ just released this news release.

NEWS RELEASE
Date 7 March 2008
Time 2:00pm

Challenges for small open economies in uncertain times

The past decade has highlighted challenges that small open economies like New Zealand face in trying to run monetary policy in a connected world, Reserve Bank Governor Alan Bollard said in remarks to be delivered at an International Symposium at the Banque de France in Paris on 7 March.

Over the past decade, the 'global savings glut', generally declining interest rates and a search for yield drove up exchange rates for many small open economies such as Australia and New Zealand, Dr Bollard said. This helped fuel a sharp increase in house prices in many countries, as well as possible collateral damage on exporters.

"Global interest rate developments have sometimes been 'out of sync', lower than domestic conditions warrant, and working against monetary policy, making it spongier, and perhaps less effective at the margin than would otherwise be the case," he said. "We have not always had an ideal mix of monetary conditions."

Dr Bollard said that conditions were changing rapidly, however, with a marked shift away from risk-taking and the pursuit of yield to heightened risk-aversion.

Though New Zealand has not seen the development of the complex financial instruments at the heart of the US's current financial problems, it is affected by the sharp changes in interest rates, credit spreads and exchange rates that have occurred recently.

"We face some quite difficult judgements in assessing how policy settings and global conditions will affect domestic economic activity and inflation in the months ahead.

"Uncertainty surrounds the future of the carry trade, the likely path of the exchange rate over the months ahead, and the nature of the projected housing slowdown. Clearly, the path of global interest rates from here on will have some bearing, given their influence on bank funding costs."

Dr Bollard said global market developments also have important ramifications for financial system stability in smaller open economies. Recent events have highlighted some risks and vulnerabilities that institutions and regulators need to ensure are properly managed.

"Banks have used a significant amount of short-term funding to minimise costs. We want to look at whether the vulnerabilities that this can create have been adequately priced and managed - noting that some of the costs of a liquidity event are probably externalities that would ultimately be borne by other New Zealand parties.

"Our institutions need to be able to cope with sharp changes in the cost of funds in the global market place," he said.

"But as we saw in July last year, we also need to confront the possibility that global funds may not always be as readily available as we perhaps used to think. The management of funding and liquidity risk by financial institutions are two areas that are likely to receive considerable policy attention in many countries over the coming months."

You can read the Governor's remarks at the following link:
http://www.rbnz.govt.nz/speeches/3258689.html

ENDS

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