The Reserve Bank's Unfortunate Experimentby Keith Rankin
On a trade-weighted basis, the New Zealand dollar has hit 74.5 (6pm, June 21), above the 74.3 peak prior to the June 11 intervention.
If New Zealand has interest rates higher than just about everyone else's (as it currently does), foreign savings are attracted to New Zealand much as moths are attracted to a light source. Intervention by the Reserve Bank to expel the inflow of monetary moths was never likely to do anything more than slow down the rate at which moths are increasingly attracted to us. In fact, the intervention probably makes us even more attractive to foreign savers.
The Reserve Bank, in trying unsuccessfully to stop the New Zealand dollar rising above 75 US cents, has actually encouraged more money to come into the country. The only reason for caution on the part of foreign "investors" is the possibility that the New Zealand exchange rate might experience a very large, rapid and sudden "correction".
The actions of the Reserve Bank have reduced the risk of a dramatic depreciation of the New Zealand dollar. Having shown a willingness to intervene when the dollar is overvalued, the Reserve Bank governor has also suggested to the markets a willingness to intervene when the dollar is undervalued or at risk of becoming undervalued. Further, by intervening to build up New Zealand's official reserves, the Reserve Bank is creating the means to intervene when the dollar is undervalued (a more difficult intervention).
By assuring "offshore" investors that their investments are less risky than they previously thought them to be, the flood of foreign money appears to be increasing rather than diminishing.
The Reserve Bank's brains trust needs to do a complete rethink. Applying a "closed economy" anti-inflation model to one of the most open economies in the world was always doomed to failure. It's time for us to abandon this unfortunate experiment, and refocus monetary policy on sorting out New Zealand's exchange rate and related balance of payments problems.
The experiment in monetary policy dates back to 1989. Today it has reached farcical proportions. There's no evidence that, since 1989, any economic indicator has been better than it would have been if the activist inflation-targeting policy had never been pursued. Many indicators are considerably worse than they would otherwise have been.
Keith Rankin teaches economics at the Unitec Business School (krankin [at] unitec.ac.nz)