Can the Reserve Bank control the value of the NZ dollar?

There has been much talk in political circles about the increasing strength of the NZ$ is and its affect on New Zealand’s current account deficit. Labour, NZ First, and the Greens have all being calling for a change to the monetary policy framework – less of a focus on inflation and more on the exchange rate. Brian Fallow of the NZ Herald referred to it as a King Canute-like to imagine in such times that the New Zealand monetary policy settings, or the framework in which the central bank operates, make a difference to the NZ dollar. Cutting the Official Cash Rate (OCR) in a bid to lower the value of the NZ$, making exports cheaper and imports more expensive, would be something that markets would see through and expect to be reversed, and could prove counter productive. Those who say that the main focus of the RBNZ should still be inflation believe that policy be directed to variables that we have some control of i.e. supply-side policies geared to improving New Zealand’s productivity and competitiveness in global markets.

What does determine the value of the NZ$

The NZ$ is deteremined a whole range of variables at different times of the growth cycle in New Zealand and in overseas markets.

* Interest rate differentials – hot money – money which is borrowed at cheap rates overseas and then invested in a currency that has relatively higher interest rates.
* Commodity prices – primary products (priced in US$) – with higher prices this means more US$ have to be converted into NZ$ which increases the value of the NZ$
* Quantitative Easing by economies – US now has implemented QE3
* Risk mentality in financial markets – when the major markets are bouyant they regain their eagerness for more risk and invest in currencies like the NZ$
* International events – with the ease of moving money globally events such as wars, oil prices, exchange rates policies of larger nations lead to more unstability in foreign exchange
* NZ$ appreciates against the AUS$ to news that the Australian economy is stronger than previously anticipated and vice-versa.

However, as Brian Fallow pointed out, the exchange rate is not just about exports and imports but the gap between investment and saving. The more we rely on importing the savings of foreigners, the more demand there is for NZ$’s the stronger it becomes.

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