Don’t join the currency wars

Published in Insights, The New Zealand Initiative’s newsletter, 28 September 2012

The new governor of the Reserve Bank of New Zealand, Graeme Wheeler, just signed a slightly revised policy target agreement with a greater focus on financial stability, but for some this is not going far enough.

A curious coalition of exporters, newspaper commentators, Labour, the Green Party, and New Zealand First wants the RBNZ to relinquish its traditional focus on inflation. Instead, they want the central bank to intervene and curb the rising exchange rate of the kiwi dollar.

At first sight, they seem to have a point. The rising kiwi dollar is hurting the export sector and domestic firms competing with now cheaper imports. A lower exchange rate would provide these companies much desired relief. In such an environment, it would also be easier to reduce New Zealand’s current account deficit.

The case for intervening on the exchange rate front looks even stronger if we consider the international monetary scene. The US Federal Reserve just announced a third, unlimited round of ‘quantitative easing’ (QE). The Bank of England is effectively doing the same. The European Central Bank has signalled its own version of QE to prop up bankrupt Eurozone economies. And the Bank of Japan has been flooding the markets with freshly created yen for two decades. All these measures will push the kiwi dollar higher.

Even the Reserve Bank of Australia is likely to cut interest rates to stop the rise of the Aussie dollar. Markets have already priced in a cut in the RBA’s cash rate of almost one per cent over the next 12 months.

So the question is: should New Zealand join the global currency debasement race?

Call me old-fashioned, but I still believe central banks have one, and only one, function: keeping prices stable.

The moment they start following other policy objectives such as exchange rates or full employment, they enter dangerous territory. Cutting interest rates to reduce the exchange rate would not only create inflationary pressures, but could also require other regulations such as new lending regulations to prevent the build-up of a property bubble. It would also necessitate central bankers with supernatural skills to get the timing right, because inflation expectations can change almost overnight.

Besides, a high exchange rate does not only create losers, but winners as well. Ask New Zealanders going on holiday or buying a new car. A rising exchange rate is the surest way of letting everyone partake in a growing economy.

The most serious argument against joining the international currency debasement race, however, is this: As central banks around the globe lay the foundation for massive future inflation, do we really want to see the same on our shores?

That the rest of the world is committing monetary suicide is no reason for New Zealand to do the same. In these crazy monetary times, New Zealand is blessed to have an old-fashioned central bank with an old-fashioned focus on price stability.

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