THE Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries.
Here is something that I put together using the the Big Mac index (July 2013) from The Economist website. Students have to complete the table below:
1. In which country was their actual exchange rate on July 2013 closest to their Big Mac exchange rate?
2. Which country’s currency is suggested by your calculations above as being
a) the most undervalued against the dollar, and
b) the most overvalued against the dollar?
3. What factors could have an influence on exchange rate values on a given date as shown in the table above.
4. In which country was their actual exchange rate on July 2013 closest to their Big Mac exchange rate?
From The Economist – Trading in foreign-exchange markets averaged $5.3 trillion a day in April 2013, reports the BIS in its latest “Triennial Central Bank Survey”. This was up from $4 trillion in 2010 and $3.3 trillion in 2007. The US dollar was the dominant currency: 87% of deals contained the dollar on one side. The euro, the second-most-traded currency, was involved in 33% of deals, down from 39% in April 2010. The third-most-traded currency, featuring in 23% of all trades, was the Japanese yen; its market share has risen by four percentage points since the previous survey. Several emerging-market currencies rose sharply in global importance. The Mexican peso and Chinese renminbi made it into the top ten for the first time.
The NZ$ is the 10th most traded currency totalling around US$27 trillion
Many thanks to A2 student Emersen Tamura-Paki for this paper on Currency Wars by Fred Bergsten which was delivered in May this year. Although it is a long document it is very readable and contains some interesting points.
* Virtually every major country is looking to keep its currency weak in order to strengthen its eocnomy and save/create jobs.
* Over 20 countries have been intervening in foreign exchange markets to suppress their currency value which has led to the build-up of reserves totaling over US$10 trillion.
* It has been led by China but includes a numer of Asian as well as several oil exporters and European countries. They account for two-thirds of global current account surpluses.
Global surpluses of currency manipulators have increased by $700-900 billion per year – see Figure 1.
* The largest loser is the USA – current account deficits have been $200bn – $500bn per year as a result. Estimate that 1 – 5 million jobs have been lost under the present conditions and likely to continue.
* Japan this year talked down its exchange rate by about 30% against the US$.
* France has called for a weaker euro – which seems the only feasible excape from many more years of stagnation. This favours, in particular, the German economy with its export growth.
However some countries have been justified in their intervention. Some countries currencies have become overvalued and produced external deficits due to widespread manipulation. Brazil and New Zealand are countries which have been justified in their intervention. Our neighbours Australia have also expressed concerns as the appreciation of the AUS$ has been the result of the significant demand for minerals from China. This does leave other exporters struggling to maintain competitiveness especially if their goods/services are elastic in nature.
The systemic problem arrises when there is continued intervention and undervaluation of currencies. Fred Bergsten illustrates the application of these principles in grid where the orange coloured cell constitutes the objectionable behaviour.
According to Bergsten the practice is widespread and the flaw in the entire international financial architecture is its the failure to effectively sanction surplus countries, especially to counter and deter competitive currency policies.
It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.
Indicators that you might want to mention are below. Notice how low global interest rates are as economic conditions have warranted greater borrowing and spending in the world economy.
The New Zealand Economy
New Zealand’s GDP expanded by 0.2 percent in the June quarter. The result was consistent with consensus forecasts, although some forecasters were expecting a decline in economic activity (due to the flow-on effects of the drought experienced earlier in the year). On an annual average basis the economy expanded by 2.7 percent over the year to the June quarter. The current account deficit totaled $9,099 million in the year ended 30 June 2013, equivalent to 4.3 percent of gross domestic product. Strong economic growth has been forecast for the second half of 2013 as the economy recovers from the drought conditions experienced earlier in the year. The annual rate of inflation is forecast to rise from its current low level back within the Reserve Bank’s medium term inflation target band of 1 – 3 percent over the coming year. The Bank is expected to commence tightening monetary policy (increase interest rates) next year as a result.
The Global Economy
The global economy continues to at very low levels. However most of the economies of the European Union remain in recession (two consecutive quarters of negative GDP). US growth has increased to 2.5% which indicates that the job market is now picking up and demand is more prevalent. Even considering the recent issue with the debt ceiling the US dollar (what is seen as the world reserve currency) has remained relatively stable – in fact it strengthened after agreement was made in Congress.
However the major emerging markets face slower growth and will take longer to come out of the downward cycle. Meanwhile, global financial markets have faced considerable volatility, owing to prospective changes in US monetary policy, a new policy in Japan, and instability in China’s banking system.
Many thanks to Kanchan Bandyopadhyay for this article from the NZ Herald on the iPad index. You will no doubt have heard of the Big Mac index which is an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries.
Australian trading company CommSec yesterday released its iPad index, which showed that New Zealand was the 26th-most expensive country in the world to buy one. The index compares the price of a 16GB iPad with retina display across 46 countries around the world in US dollars to compare the value of the world’s currencies.
The survey found the following:
* Argentina is the most expensive country to buy an iPad – US$1094.11
* Brazil is second with prices of $791.40
* Malaysia is the cheapest country to buy an iPad US$473.77
* Australia is the fourth cheapest US$507 – NZ$604.87
Ipad Index – NZ$ – Aus$
One New Zealand dollar currently trades for about 89 Australian cents. Comparing the price of iPads, the New Zealand dollar is worth about 83 Australian cents, which would suggest the two currencies are trading at a fair value.
Ipad Index – NZ$ – US$
An iPad in the United States is similarly cheap, costing about US$499 (NZ$595.32) and one dollar in New Zealand is worth about $0.81 in the United States, compared with the current trading value of $0.84.
Ipad Index – NZ$ – Yuan
However, in China, where many iPads are produced, the Kiwi dollar appears expensive. An iPad costs US$602.52 (NZ$719.40), suggesting the two currencies share a similar value. In the current foreign exchange market, the New Zealand dollar is worth about 5.13 Yuan.
Ipad Index – NZ$ – UK
New Zealand’s value against the UK Pound Sterling tells the opposite story, where it costs US$639 ($762.35), five per cent more expensive than in New Zealand. One New Zealand dollar is currently worth a significantly cheaper 52 pence.
If you are revising exchange rates here is a video clip from AlJazeera. India’s rupee has plunged more than 3.6 percent to a new record low against the US dollar amid deepening economic woes.
The rupee, one of Asia’s worst-performing currencies this year, breached 68.75 against the dollar in morning trade on Wednesday, after sliding three percent a day before.
The rupee has now fallen about 19 percent so far this year, by far the biggest decliner among the Asian currencies tracked by Reuters. The need to attract foreign capital is critical for a country whose record high current account deficit is a key reason behind the rupee’s slump.
Yet policymakers have consistently struggled to come up with measures that can convince markets they can stabilise the currency and attract funds into the country.
Those comments came after the government approval of infrastructure projects were overtrumped by concerns about the fiscal deficit after India’s lower house of parliament this week approved a 1.35 trillion rupees plan to provide cheap grain to the poor.
That failure is becoming an increasing source of tension for India at a time when fears of a possible US-led military strike against Syria are knocking down Asian markets, with the prospect that the Federal Reserve will end its period of cheap money as early as next month further raising concerns.
Some key statistics:
* Trading in the NZ$ represents about 2% of global foreign exchange turnover of US$5.3 trillion.
* New Zealand accounted for 0.2% of global forex trading
* London accounted for 41% of global forex trading
* Most trading in NZ was in exchange for US$ – US$82 billion a day.
Franz Nauschnigg wrote a piece in Project Syndicate about an emerging imbalance in the goods and services deficits that Portugal, Italy, Ireland, Greece and Spain (PIIGS) have with China. Up to 2004 the biggest deficits of the PIIGS economies was with the rest of the eurozone. But in subsequent years the figures were the following:
From the figures you can see that over the last 4 years the deficit with China has remained significant while it has narrowed with the eurozone especially with Germany. There are two reasons for this:
1. The euro has appreciated against the renminbi.
2000 – € = ¥7.4
2007 – € = ¥10.4
With this appreciation the eurozone countries exports became less competitive. The early 2000’s saw a lot of investment into the PIIGS economies which increased inflation and prices.
2. With the southern economies dependent on textiles, footwear etc the stronger euro made Chinese imports a lot cheaper than the domestic alternative. The IMF acknowldeged the fact that Chinese exports were responsible for the deficits in the PIIGS but Northern Europe wasn’t as badly affected as their export focus is more machine based which China is not able to compete with.
With monetary and fiscal expansion becoming ineffective external adjustments under three conditons might be the answer:
1. Stronger external demand
2. A less onerous financing environment
3. A weaker euro
Much of the above could be achieved by a weaker euro against the renminbi. This would provide the boost to export revenue and reduce fiscal and external deficits.
In a free market the rate of exchange is determined by the market forces of supply and demand. Where these conditions apply the exchange rate is said to free, fluctuating or floating. Therefore the following have a great impact on the rate of exchange in a free market:
An increase in the demand for the $NZ will result from more people wanting get or buy $NZ.
* Increase in the value of exports
* Increase in tourists travelling to NZ
* Increase in foreign investment in NZ (buying assets / companies / depositing savings)
* Increase in NZer’s taking out loans overseas
An increase in the supply for the $NZ will result from more people wanting get or buy other currencies (as they have to supply $NZ to the market to get the other currencies)
* Increase in the value of imports
* Increase in NZer’s travelling to other countries
* Increase in NZ investment overseas
* Increase in NZer’s repaying loans made overseas
For these purposes NZ residents must obtain foreign currencies. Banks, acting on their behalf, will buy these currencies in the foreign exchange market and pay for them with dollars. Thus, an increase in NZ imports will increase the supply of dollars in the foreign exchange market. With floating exchange rates, changes in market demand and market supply of a currency cause a change in value.
An example using the US$ and Euro
French citizens want to buy goods from the USA and supply euros (Graph A) to their banks and demand dollars (Graph B) to import goods and services from the United States. The value of the euro falls from $1.00 to $0.98. Simultaneously, the value of the dollar appreciates from 1.00 to 1.02 euros.
If U.S. citizens want to buy goods from France they must supply dollars to their banks (Graph C) to demand euros to import goods and services from France (Graph D). The value of the dollar falls from 1.02 euros to 1.00 euro.
I was fortunate enough to attend the Institute of Directors breakfast where RBNZ Governor Graeme Wheeler was the guest speaker. He spent a lot of time focussing on the overvalued NZD and that keeping the OCR low is a an effort to weaken its value. He did mention that the RBNZ has intervened in the FX market by buying foreign currency with NZD – supply increases therefore value should drop. In assessing whether to intervene in the exchange market, the RBNZ apply four criteria.
1. Is the exchange rate at an exceptional level,
2. Whether its level is justifiable,
3. Is intervention consistent with monetary policy, and
4. Are market conditions conducive to intervention having an impact.
This last factor is especially important given the volume of trading in the Kiwi. In the most recent survey – April 2010 – by the Bank for International Settlements, the Kiwi was the tenth most traded currency in the world with daily turnover of spot and forward exchange transactions totaling around USD $27 billion.
“We can only hope to smooth the peaks off the exchange rate and diminish investor perceptions that the New Zealand dollar is a one-way bet, rather than attempt to influence the trend level of the Kiwi.” Graeme Wheeler – RBNZ Governor
See the graph below for the value of the NZD after his speech.
For many years after the Second World War most countries operated a system of fixed exchange rates. The external value of a currency was fixed in terms of the US$ and the value of the US$ itself was fixed in terms of gold. In effect, therefore, the values of the currencies were fixed in terms of gold. The ‘fixed’ rate was not absolutely rigid. The value of a currency was allowed to vary within a narrow band of 1 or 2% on each side of the ‘fixed’ rate or parity. For example, if the value of the NZ$ were fixed at NZ$1 = US$0.50, a permitted deviation of 2% would allow it to vary between NZ$1 = US$0.51 and NZ$1 = US$0.49. These limits are often described as ‘the ceiling’ and ‘the floor’. Central banks were responsible for maintaining the values of their currencies within the prescribed bands. They are able to do this by acting as buyers or sellers of the currency in the foreign exchange market. For this purpose each central bank must have a fund containing supplies of the home currency and foreign currencies.
The way in which the Reserve Bank of New Zealand can use its funds of currencies to influence the exchange rate can be explained by making use of the diagram below. Let us assume that the value of the NZ$ has been fixed at A and, initially, the market is in equilibrium at this exchange rate. The permitted band of fluctuation is PP1 and the value of the pound must be held within these limits. A large increase in imports now causes an increase in the supply of NZ$’s in the foreign exchange market. The supply curve moves from SS to S1S1 causing a surplus of NZ$’s at the ‘fixed’ rate (A). If no intervention takes place, the external value of the
NZ$ will fall to B which is below the permitted ‘floor’.
The Reserve Bank will be obliged to enter the market and buy NZ$. In doing so that will shift the demand curve to the right and raise the value of the NZ$ until it is once again within agreed limits. In the diagram below intervention by the Reserve Bank of NZ has raised the exchange rate to C.
When the Reserve Bank of New Zealand is buying NZ$’s, it will be using up its reserves of foreign currencies; when buying NZ$’s it exchanges foreign currencies for NZ$’s. ‘Supporting the NZ dollar’, that is, increasing the demand for NZ$’s, therefore leads to a fall in the nation’s foreign currency reserves. In the opposite situation where an increased demand for NZ$’s tends to lift the value of the NZ$ above the permitted ‘ceiling’, the central bank will hold down its value by selling NZ$’s. This will increase the supply of NZ$’s and lower the exchange rate. When the Reserve Bank is selling NZ$’s it will be increasing its holdings of foreign currencies.
The main argument for a fixed exchange rate is the same as that against a floating rate. A fixed rate removes a major cause for uncertainty in international transactions. Traders can quote prices which will be accepted with some degree of confidence; buyers know that they will not be affected by movements in the exchange rate. The risks associated with international trade are lessened and this should encourage more trade between nations and more international borrowing and lending.
In theory, an advantage of a floating exchange rate is that it will automatically correct any tendency for the balance of payments to move into surplus or deficit. The following sequence of events shows how this automatic correction is supposed to work.
• Assume the NZ balance of payments is initially in equilibrium.
• Assume now that export values remain unchanged, but an increased demand for $ tends to move the NZ B of P into a deficit.
• This increased demand for imports will increase the supply of dollars in the foreign exchange market.
• The external value of the dollar will fall and this will make exports cheaper and imports dearer.
• The changes in the relative prices of exports and imports will increase the volume of exports and reduce the volume of imports and the B of P will be brought back into equilibrium.
In practice it may not work out like this because the supplies of exports and imports may be slow to adjust to the price changes. For example, if the prices of exports fall, it may take considerable time before the increased quantities demanded can be supplied. There are also problems associated with the elasticities of demand for exports and imports. A 10% fall in the prices of exports will not increase the amount of foreign currency earned unless the quantities demanded increase by more than 10%. A further problem is that a depreciation of the pound increases import prices and, since New Zealand imports a large amount of raw materials and manufactures, this has the effect of raising the cost of living and the costs of production in many industries.
A disadvantage of the system of floating exchange rates is the fact that greatly increases the risks and uncertainties in international trade.
For example, an Auckland manufacturer of cotton cloth may be quoted a firm US$ price by his American supplier, payment due, say, in 3 months. He will still not be certain of the costs of his cotton because he does not know what the US$-NZ$ exchange rate will be when he comes to make payment.
If he is quoted US$500 for a bale of cotton and the exchange rate stands at:
NZ$1 = US$0.56, a bale of cotton will cost him NZ$892.86.
If, however, by the time he comes to make payment, the exchange rate has moved to:
NZ$1 = US$0.53, a bale of cotton will cost him NZ$943.40.
Speculators remove some of this uncertainty by operating a forward exchange market where they guarantee to supply foreign currency at some future date at a price agreed now.
A perfectly free market in foreign currency is not likely to be found in the real world. Even when currencies are said to be floating, governments tend to intervene in the market to smooth out undesirable fluctuations. The central bank (Reserve Bank in NZ) is responsible for this type of intervention and the way it operates is explained in the next section.
Advantages of a Strong Dollar
• A high NZ$ leads to lower import prices – this boosts the real living standards of consumers at least in the short run – for example an increase in the real purchasing power of NZ residents when traveling overseas
• When the NZ$ is strong, it is cheaper to import raw materials, components and capital inputs – good news for businesses that rely on imported components or who are wishing to increase their investment of new technology from overseas countries. A fall in import prices has the effect of causing an outward shift in the short run aggregate supply curve
• A strong exchange rate helps to control inflation because domestic producers face stiffer international competition from cheaper imports and will look to cut their costs accordingly. Cheaper prices of imported foodstuffs and beverages will also have a negative effect on the rate of consumer price inflation.
Disadvantages of a Strong Dollar
• Cheaper imports leads to rising import penetration and a larger trade deficit e.g. the increasing deficit in goods in the NZ balance of payments in 2011
• Exporters lose price competitiveness and market share – this can damage profits and employment in some sectors. Manufacturing industry suffered a steep recession in 2011 partly because of the continued strength of the NZ$, leading to many job losses and a sharp contraction in real capital investment spending and the lowest profit margins in manufacturing industry for over a decade
• If exports fall, this has a negative impact on economic growth. Some regions of the economy are affected by this more than others. The rural areas are affected by a strong dollar in that our produce becomes more expensive to overseas buyers.
Thanks to AS student Carlos McCoy for some information on Bitcoin. BITCOIN, the world’s “first decentralised digital currency”, was launched in 2009 and unlike traditional currencies, which are issued by central banks, Bitcoin has no central monetary authority. Instead it is underpinned by a peer-to-peer computer network made up of its users’ machines, akin to the networks that underpin BitTorrent, a file-sharing system, and Skype, an audio, video and chat service. However in today’s environment it does maintain a good store of value relatively speaking when you look at alternative currencies. Below is Max Keiser with some very good points.
There has been numerous mentions in the media about the need to reduce the strength of the NZ$. RBNZ Governor Graeme Wheeler outlined some of these in a recent speech. He identified the following policy responses:
1. Lowering Interest Rates
By lower interest rates you may reduce pressure on the exchange rate as long as the new rate is uncompetitive to those in other countries. However a one-off reduction in the interest rate which conflicts wtih the policy of the central bank’s inflation target could lead to expectations of a subsequent reversal. Examples of when it hasn’t work:
Australia – since the end of 2010 RBA cut its official cash rate by 1.75% – no significant impact on the AUS$.
Japan – on the other hand the Yen actually appreicated by over 30% between February 2007 and November 2012 when the interest rates was lowered to 0 – 0.1%.
Switzerland – The Swiss Franc appreciated by 20% between Jan 2010 – July 2011 despite interest rates being lowered between 0 – 0.75%
2. Intervening in the Foreign Exchange Market
The RBNZ have 4 criteria it uses to decide whether to intervene in the foreign exchange market.
1. Is the exchange rate at an exceptional level?
2. Is its value justified?
3. Is intervention justified with current monetary policy?
4. Are market conditions conducive to achieving the desired outcome?
Global exchange rate turnover is between US$4 -5 trillion per day and it is estimated that the NZ$ is the 10th most traded currency in the world. The RBNZ has indicated that it is prepared to intervene but can only attempt to smooth the peaks of the US$ – NZ$ exchange rate.
3. Quantitative Easing – printing money.
This has been adopted by the US central bank in response to teh global financial crisis. However New Zealand was not exposed to risky investments to the extent that other countries were. New Zealand’s challenges are different from those in the US, Euro zone etc. The printing of more money would put upward pressure on inflation, especially asset prices, and ultimately lead to higher interest rates.
4. Cap the exchange rate – the Swiss experience
The Swiss National Bank spent had some success in capping the Swiss franc to the Euro – SFr 1.2 – 1 euro. This woud be very risky for New Zealand – Swiss lost approximately
NZ$35bn in the process. New Zealand would need to intervene to the same extent and the interest rates would need to drop to 0% also. The capping would amount to quantitative easing which with 0% interest rates would be inflationary.
Graeme Wheeler finished up by saying:
The New Zealand economy currently faces an overvalued exchange rate and overheating house prices in parts of the country, especially Auckland. The Reserve Bank will be consulting with the financial sector next month on macro-prudential instruments. These instruments are designed to make the financial system more resilient and to reduce systemic risk by constraining excesses in the financial cycle. They can help to reduce volatile credit cycles and asset bubbles, including overheating housing markets, and support the stance of monetary policy, which could be helpful in alleviating pressure on the exchange rate at the margin.
Japan’s Prime Minister Shinzo Abe recently addressed parliament stating that he plans to reverse the trend of issuing bonds to raise money but raise more in taxes. Japan cannot beat deflation and a strong currency (yen) if it adheres to the same policy of the past decade.
However his speech comes after the announcement of a $226.5bn stimulus package earlier in the year and this when Japan already has some serious debt issues – public debt that is almost three times the size of the Japanese economy.. He also wants the Bank of Japan to maintain an open-ended policy of quantitative easing (QE) and a doubling of the inflation target – 2%. Hopefully the fiscal stimulus package accompanied by more QE will drive down the price of the yen which will make Japanese exports more competitive. He stated his three arrows of economic policy:
1. Aggressive Monetary Easing
2. Flexible fiscal spending
3. A growth strategy that would induce private investment
Who knows if it will work but Shinzo Abe stated that it is worth the gamble.
The Economist first compared the price of a McDonald’s Big Mac in a number of countries in 1986. It regarded the long-established Big Mac as the perfect universal commodity now produced locally in sixty-six countries. If the prices of a Big Mac in several countries in local currencies were expressed in dollars using the exchange rate, then it would be possible to see whether exchange rates do equalize the prices of an identical commodity such as a Big Mac. It is evident that a dollar does not buy the same amount in each of these nine countries. The question arises as to whether the exchange rate between the dollar and the currency of each of the countries shown below moves in the long run to equalize prices of an identical product such as a Big Mac. Some economists think this is the case.
From the data currently the $NZ is undervalued by 1%. How does it work?
In January 2013 a Big Mac in the USA was US$4.37.
In New Zealand it was NZ$5.20
Therefore the exchange rate for Big Mac’s = 5.20/4.37 = US$1 = NZ$1.19
The actual exchange rate at the time was US$1 = NZ$1.20
Big Mac index is 1% undervalued.
But differences in the prices of hamburgers could exist in the real world for a number of reasons which could lead to apparent deviations from equilibrium exchange rate values. This relates to:
If beef production is subsidised in some countries more than others, then this could be expected to affect local prices of a Big Mac. There could also be differences in the tariffs on beef imports in different countries. Furthermore other costs regarding bread and salad could also impact on
Beef may not be a suitable commodity to compare relative prices where, for religious reasons say, it is not regarded as an appropriate main item of diet.
Click below to go to the interactive graph.
Economist Big Mac Index
The BNZ Markets Outlook looked at reasons why Graeme Wheeler, the RBNZ Governor, might keep a ‘steady as she goes’ attitude to Thursday’s OCR review. Below are some thoughts as to why he could be swayed to increase or decrease the OCR rate.
With all that said it is expected that Graeme Wheeler will leave the OCR unchanged at 2.5%.
With current central bank interest rates at very low levels there is concern that these policies have been fueling credit and asset price booms in some emerging economies. However, potentially there could be significant fallout of the unwinding of these booms on developed nations.
How do Capital Flows impact on an economy?
When you have long periods of loose monetary policy (including low interest rates), like that in the US 0-0.25% – since September 11 2001 the US Federal Reserve has implemented a near zero rate policy which is now expected to last until 2014. According to Stanford University Professor John Taylor this results in the following:
1 Investors look elsewhere to gain higher returns and buy foreign securities and
2 Low interest rates encourage overseas firms to borrow in US dollars rather than in their domestic currency – US branch offices of foreign banks raised over $645 billion to make loans in overseas countries.
This flow of money means that the strength of the local currency starts to appreciate as foreign firms exchange their borrowed US$ and for the domestic currency. With this appreciation, the central bank becomes concerned with the affect the higher currency is having on the exchange rate and therefore export competitiveness.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.
A little over a decade ago the Australian dollar was being dismissed as the Pacific Peso but today some are referring to it as the Swiss Franc of the south. This is an indication of its safe-haven status as central banks worldwide start to diversify their reserves away from US dollars and Euros into Aussie dollars.
The IMF recently announced that they intend to make the Australian dollar and Canadian dollar Global Reserve Currencies. Both will be included in the COFER (Currency Composition of Official Foreign Exchange Reserves) surveys, which currently consists of the:
The IMF is asking member countries from next year to include the Australian and Canadian dollar in statistics supplied by reserve-holding nations on the make-up of their central banks’ foreign exchange reserves. In previous years the world has had just two reserve currencies:
1. Sterling up to 1914
2. US dollar since the WWI
Notice the drop in the Australian dollar during the start of the financial crisis but its strengthening since 2009. Australia is just one of only seven countries in the world with a AAA-rating from all three global credit ratings agencies – Moodys, Standard & Poors, and Fitch.
From reading the October 2012 IMF Fiscal Monitor I came across a page on the Swedish model of managing its public finances. Obviously the IMF see this as a good example for other economies to follow. At the bottom of the recession in 2009 the fiscal deficit in Sweden was only 1% of GDP and by 2011 it was at pre-crisis levels. The IMF publication identified four main points that other countries could learn from.
1. The building up of fiscal buffers during good times, together with credible fiscal institutions, provides room to maneuver during bad times.
Before the GFC Sweden enjoyed a fiscal surplus of 3.5 percent of GDP, compared with an average deficit of 1.1 percent of GDP among advanced economies. When the recession hit the government had enough fiscal space to allow automatic stabilizers to operate fully and to implement stimulus measures without jeopardizing fiscal sustainability. The fiscal balance went from a surplus of 3.5 percent of GDP in 2007 to a relatively small deficit of 1 percent of GDP in 2009. The authorities’ expansionary policy was not called into question by markets because of the low level of the deficit and the credibility of Sweden’s comprehensive fiscal policy framework—including a top-down budget process, a fiscal surplus target of 1 percent of GDP over the output cycle, a ceiling for central government expenditure set three years in advance, a balanced-budget requirement for local governments, and an independent fiscal council.
2. Central bank credibility allows monetary policy to be used aggressively.
During the crisis, the Riksbank lowered its target short-term interest rate nearly to zero and implemented sweeping liquidity measures, including long-term repurchase agreement operations and the provision of dollar liquidity.
3. A flexible exchange rate can help absorb the shock.
During the crisis, the krona fell in value against both the dollar and the euro as investors flocked to reserve currencies. It depreciated by 15 percent in real effective terms from mid-2008 to early 2009, supporting net exports and helping prop up economic activity.
4. Decisive action to ensure financial sector soundness is crucial.
Swedish banks were badly hurt by the financial crisis, despite their negligible exposure to U.S. sub- prime assets. Bank profitability fell sharply in 2008– 09, and two of the largest banks — both increasingly funded on wholesale markets and exposed to the Baltics — saw their loan losses spike and their share prices and ratings decline accordingly. The authorities took fast action to calm depositors and inter- bank markets, including a doubling and extension of the deposit guarantee and introduction of new bank recapitalization and debt guarantee schemes.