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New Zealand's Exchange Rate Cycles: Evidence and Drivers

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New Zealand's Exchange Rate Cycles: Evidence and Drivers A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Mabin, Gemma Working Paper New Zealand's Exchange Rate Cycles: Evidence and Drivers New Zealand Treasury Working Paper, No. 10/10 Provided in Cooperation with: The Treasury, New Zealand Government Suggested Citation: Mabin, Gemma (2010) : New Zealand's Exchange Rate Cycles: Evidence and Drivers, New Zealand Treasury Working Paper, No. 10/10, New Zealand Government, The Treasury, Wellington This Version is available at: http://hdl.handle.net/10419/205613 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ www.econstor.eu New Zealand’s Exchange Rate Cycles: Evidence and Drivers Gemma Mabin N EW Z EALAND T REASURY W ORKING P APER 10/10 D ECEMBER 2010 NZ TREASURY New Zealand’s Exchange Rate Cycles: Evidence and Drivers WORKING PAPER 10/10 MONTH/ YEAR December 2010 AUTHOR Gemma Mabin PO Box 3724 Wellington 6008 NEW ZEALAND Email [email protected] Telephone +64 4 917 6894 ACKNOWLEDGEMENTS The author would like to thank Mark Blackmore, Anne-Marie Brook, John Janssen, Paul Gardiner, Michael Reddell and Renee Philip for their substantial input at various stages in the preparation of this paper. NZ TREASURY New Zealand Treasury PO Box 3724 Wellington 6008 NEW ZEALAND Email [email protected] Telephone +64 4 472 2733 Website www.treasury.govt.nz DISCLAIMER The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author. They do not necessarily reflect the views of the New Zealand Treasury. The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in this Working Paper. The paper is presented not as policy, but to inform and stimulate wider debate. Foreword The Treasury’s vision statement focuses on higher living standards for New Zealanders. While a range of factors underpin well-being, raising New Zealand’s economic performance is a central driver of permanently higher standards of living. New Zealand faces two key economic challenges that need to be addressed if our economic performance is to lift. These are: accelerating productivity growth to raise average incomes per person and to close the income gap with other wealthier countries; and reducing imbalances in order to better position us to weather the inevitable economic or financial shocks that will impact our economy in the future. This paper is one of a suite of four papers that examine key elements of New Zealand’s economic performance and the macro- and micro-economic factors that are inhibiting productivity growth and contributing to economic imbalances. These papers follow on from Treasury’s earlier suite of papers examining New Zealand’s productivity performance.1 The four papers in the series are: Why are Real Interest Rates in New Zealand so High? Evidence and Drivers — examining interest rates in New Zealand, the apparent premium relative to overseas rates, potential drivers of this interest rate differential and the impact this might be having on investment; New Zealand’s Exchange Rate Cycles: Evidence and Drivers — with a key focus on examining the nature of New Zealand’s exchange rate cycle over the medium term and possible drivers for this cycle; Economic Imbalances: New Zealand’s Structural Challenge — examining the imbalances in New Zealand’s economy and their implications for resilience; and New Zealand’s Exchange Rate Cycles: Impacts and Policy — focusing on the impact that New Zealand’s exchange rate cycle has on the tradable sector and wider economic performance and possible policy responses. The papers are being published to articulate the Treasury’s current thinking on these issues. Our hope is that these papers will spark further debate on these important topics and stimulate further research that further advances our collective understanding of New Zealand’s economic performance and possible policy change that may lift it. 1 http://www.treasury.govt.nz/publications/research-policy/tprp WP 10/10| New Zealand’s Exchange Rate Cycles: Evidence and Drivers i Abstract This paper seeks to understand the extent of New Zealand’s exchange rate fluctuations compared to others, and what drives New Zealand’s exchange rate. New Zealand has only experienced a limited number of exchange rate cycles since the dollar was floated. On a trade-weighted basis this paper finds that New Zealand has large exchange rate cycles, but that some other relevant economies (e.g. Australia, the Euro Area, Japan and South Korea) also have similarly large cycles. By comparing the short- term (i.e. month-to-month) volatility of New Zealand’s exchange rate to other economies, on a trade-weighted basis New Zealand’s exchange rate fluctuates greatly. New Zealand, Australia and Japan face the highest levels of short-term volatility out of the economies included in the analysis. Factors that affect the expected relative return on New Zealand dollar assets are found to explain a significant part of exchange rate cycles. These include interest rate differentials between New Zealand and other countries, relative growth performance and attitudes to risk. More fundamental drivers such as export commodity prices and the terms of trade, and productivity growth also drive New Zealand dollar returns. The main driver of the exchange rate changes over time in response to developments in the domestic and global economy. JEL CLASSIFICATION F31 – Foreign exchange KEYWORDS Exchange rate, short-term volatility, medium-term cycles, long-run equilibrium WP 10/10| New Zealand’s Exchange Rate Cycles: Evidence and Drivers 1 Table of Contents Foreword ............................................................................................................................. i Abstract .............................................................................................................................. 1 New Zealand’s Exchange Rate Cycles: Evidence and Drivers ...................................... 3 1 Introduction .............................................................................................................. 3 2 Framework ................................................................................................................ 3 3 Evidence on exchange rate volatility and variability ............................................ 6 3.1 Short-term (month-to-month) volatility ............................................................................8 3.2 Medium-term variability .................................................................................................13 4 Drivers of the exchange rate ................................................................................. 18 4.1 Medium-term cycles ......................................................................................................18 4.2 Equilibrium level ............................................................................................................24 5 Conclusion .............................................................................................................. 27 6 References .............................................................................................................. 28 List of Tables Table 1: Amplitude and duration of real effective exchange rate cycles .........................................15 List of Figures Figure 1: New Zealand’s real trade-weighted exchange rate ............................................................. 4 Figure 2: New Zealand’s real and nominal trade-weighted exchange rate ........................................ 4 Figure 3: Stylised path for the real exchange rate .............................................................................. 5 Figure 4: Real effective exchange rate volatility ................................................................................. 8 Figure 5: Nominal bilateral exchange rate volatility ............................................................................ 9 Figure 6: Bilateral nominal exchange rates .......................................................................................10 Figure 7: Nominal exchange rate volatility against the US dollar .....................................................11 Figure 8: Real effective exchange rate volatility: different exchange rate regimes ..........................12 Figure 9: Real effective exchange rate
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