The Reserve Bank had been experiment-
ing with the implementation of monetary policy for more than decade, when it abandoned the Monetary Conditions Index (MCI) as the main instrument of policy management in March last year. As Bank of New Zealand chief economist Tony Alexander tartly observed then, its experiments obviously had not yielded the stability or transparency it wanted. At long last, therefore, it had decided to do what other central banks do and use an official cash rate (OCR).
The most obvious effects of that decision would be to stabilise interest rates by anchoring them to the OCR. The exchange rate was likely to become more volatile.
Several factors prompted the Reserve Bank to introduce the OCR. The MCI was misunderstood in overseas money markets; it produced illogical interest rates (they rose to l0 percent when the economy was in recession, for example); and it was too rigid, requiring strict trade-off between interest rates and the exchange rate without room for the ups and down of the economic cycle.
On the other hand, adopting an OCR would enable the banks to be more certain, when they charged their deposit and floating mortgage rates, and they would tend to wait to see if the OCR was changed, every six weeks or so, before making changes.
More stable interest rates would be positive for borrowers and investors. This should help to make New Zealand more attractive to overseas investors, analysts predicted. Those investors would find it easier to take view on monetary policy and its effect on interest rates in this country.
Exporters were reported to have welcomed the change, too, even though the exchange rate would tend to be more volatile. Their confidence was rooted in the Reserve Bank’s announcement there would be no interventions in the foreign exchange rate market, unlike central banks overseas which have adopted OCRs.
The most fundamental change since then has been the gradual tightening of monetary conditions, effected by raiding the OCR in November and February. Ninety-day bill rates, accordingly, have risen slowly from around 4.6 percent in March 1999 to 5.9 percent late in February.
The exchange rate has bounced about bit but basically has declined. The trade weighted index (TWI) fell from 58.1 in March last year to 53.6 late February and against the US dollar the Kiwi was floundering at 14 year lows, worth around US49c after shedding more than US3c in month.
ACT leader Richard Prebble was looking at ups and downs in the Kiwi dollar over much longer period of time, however, when he aired his ideas on how we should reduce volatility in the currency and avoid interest rate rises. His concern was the failure of our exports to grow much more substantially, as they have done in other countries, over the past 30 years. Monetary independence, he suggested, was carrying high price and maybe we should adopt currency like the American dollar or join currency union.
In manufacturing the return is often as low as four percent,” and when you have dollar losing four percent in night, there is no hedging programme for that, Prebble says.
Staff in Finance Minister Michael Cullen’s office said examining the possibility of monetary union was not on the Government’s agenda. Thus the new Government seemed no more willing to examine the idea than National prime minister Jenny Shipley had been year earlier. unified currency with Australia was not being considered, she had insisted, “I have always said I see no reason why we should consider it.” Her disdain didn’t snuff debate or research. Treasury paper was among the many to mount case for New Zealand to consider entering monetary union with Australia or the United States. An Australia-New Zealand business council study on monetary union, due to be completed by the end of March, will further fuel interest.
There’s good reason for governments to want to cling to the Kiwi, however. Without it, they will no longer be able to exert control over it.
Bob Edlin is Wellington-based economic commentator and journalist.
