RBNZ keeps OCR at 2.5%

Today Alan Bollard, Governor of the Reserve Bank of New Zealand, unsurprisingly kept the Official Cash Rate at 2.5%. One area of concern in today’s statement was the NZ dollar – the RBNZ would prefer to see it a lower levels (see notes below on advantages and disadvantages of a strong dollar). Therefore the future direction of NZ dollar will be critical to interest rate decisions. The bank did suggest that they would hold off on rises with the sustained strength of the NZ dollar.

The Output Gap
The output gap refers to the difference between potential GDP and actual GDP or actual output. According to the BNZ the Treasury produced three estimates of the output gap using various filtering techniques. They were all close to zero, with one slightly abovevand two slightly below. If this is where the true output gap currently sits, it means there is little spare capacity in the economy. So, any reasonable growth is likely to lead to inflationary pressure before too long. It could yet turn out that the RBNZ does not have that much time up its sleeve, before medium term inflation pressures emerge. That though, is likely to be a story for later in the year.

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 2001
• Exporters lose price competitiveness and market share – this can damage profits and employment in some sectors. Manufacturing industry suffered a steep recession in 2001 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.

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