The High Exchange Rate: What Is the Government Doing? What Can It Do Further?

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This note was prepared for a client in mid December 2005

Keywords: Macroeconomics & Money;

Background
1. The over valued exchange rate reflects imbalances in the New Zealand economy, particularly the savings deficit.
2. It is also partly the consequences in the world economy, particularly the US government deficit.
3. New Zealand needs to end its imbalances in order to be ready when the world goes through what may be a chaotic time as it ends its imbalances.
4. There are no quick fixes The forward exchange market will dampen the effect of any policy measures.
5. There is a need to avoid rapid and drastic adjustment in order to avoid a hard landing.

What is the Government Doing?
1. The Reserve Bank is unable to carry the burden of adjustment. It is coordinating with Fiscal Policy.
2. The Governor and the Government are trying to talk down unrealistic expectations of house prices.
3. The Governor and the Government are trying to talk down unrealistic expectations of a sustainable exchange rate.
4. Higher interest rates will help slow down housing spending, and may encourage more consumer saving (although they impact unfavourably on the exchange rate in the short run).
5. Fiscal policy remains tight. The New Zealand government has one of the strongest public balance sheets in the world, and it aims to keep it that way.
6. A government expenditure review aims to reduce wasteful spending.
7. The government has various policies to increase household savings. (It should speed up their implementation.)
8. It is reviewing business taxation with an intention of encouraging business investment.

What Can the Government Do Further?
1. It is reviewing the monetary system to ensure that the international money flowing into housing and consumer debt is adequately regulated.
2. It could review the taxation system to reduce distortions in the housing investment market (with a minimum of impact on home ownership).
3. It could offer more investment opportunities in New Zealand by opening up opportunities for long term investors in SOEs.

What Else Needs to be Done?
1. There needs to be a public enquiry into the best way to measure the impact on the economy of the government’s fiscal activities. A good venue would be the Select Committee on Finance.