Looking for a better exchange rate

Press, 27 January 1986, Page 12

Looking for a better exchange rate

By

ADRIAN BROKKING

One of the major uncertainties in the outlook for the New Zealand economy is the exchange rate and its impact on overseas trade. The New Zealand dollar reached very high levels for a few months last year, but its value came down in November, following a downturn in interest rates. Since then it has remained firm at current levels. Unfortunately, the strength in the New Zealand currency coincided with depressed world markets for agricultural products and a depreciating Australian dollar, which put a strong brake on export growth. The overseas balance of payments deficit is likely to increase to an unacceptably high level, and no growth in exports can be expected unless the N.Z. dollar depreciates to a level some 8 to 10 per cent below its present value — i.e. around 60 on the trade-weighed index. If sustained, the current sharp drop in oil prices will be a step in the right direction. The question has been asked how can economists de so certain that the New Zealand dollar is too high, ind how can they forecast that the dollar will fall. Few economists or currency traders would be as rash as to predict shortterm movements in the exchange rate. In the very short run, say up to two weeks, the rate is set by day-to-day supply and demand, and movements ire likely to be random ind unpredictable. In the long run, say nore than six months, the

exchange rate should reach a level where the overseas deficit is wiped out and exports and imports are matched. That is behind the whole idea of a floating exchange rate. The “correct” level of the exchange rate can roughly be calculated, as it is a function of the terms of trade. It is determined by the relationship between world prices expressed in a basket of world currencies, and world prices in New Zealand currency. An equilibrium rate of exchange would equalise New Zealand costs and prices with overseas costs and prices expressed in New Zealand currency. Conceptually such a calculation is easy, but in practice there are very many considerations to be taken into account. In any case, the mere fact that the balance of payments deficit is not only not diminishing but actually growing clearly demonstrates that the exchange rate is too high. However, an exchange rate can be out of equilibrium for quite a long

time, as the American experience has shown. If there is a strong demand for a currency for other than trade purposes, especially for investment, the exchange rate may remain high, and although captital may enter the country, this does not help exporters nor does it protect domestic manufacturers against cheaper imports. High interest rates keep the value of the currency high. The Government is of course aware of this, and when in November the Prime Minister announced that it would modify its economic and monetary policies to take other objectives into account he probably meant that the value of the New Zealand dollar would be one factor in Government policy making. Lower inflation and lower Interest rates would help the balance of payments deficit; unfortunately the large Government stock tender programme sets an effective floor below which rates cannot fall.