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NEW ZEALAND NEW ZEALAND NEW ZEALAND NEW ZEALAND AND THE WOODY ALLEN AND THE WOODY ALLEN AND THE WOODY ALLEN AND THE WOODY ALLEN SYNDROME SYNDROME SYNDROME SYNDROME

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SEBASTIAN EDWARDS SEBASTIAN EDWARDS

University of California, Los Angeles University of California, Los Angeles Wellington, New Zealand Wellington, New Zealand June, 2011 June, 2011

A certain volcano A certain volcano A certain volcano… A certain volcano…

What does Woody Allen have What does Woody Allen have to do with all of this? to do with all of this?

Contents Contents

 The “Unofficial

The “Unofficial-Official” Story: An Official” Story: An The Unofficial The Unofficial Official Story: An Official Story: An Assessment Assessment H U i i N Z l d’ R l H U i i N Z l d’ R l

 How Unique is New Zealand’s Real

How Unique is New Zealand’s Real Exchange Rate Behavior? Exchange Rate Behavior?

 International Competitiveness and the Non

International Competitiveness and the Non-

• Tradables

Tradables Sector Sector Tradables Tradables Sector Sector

 Some Reflections on Vulnerability

Some Reflections on Vulnerability

 Concluding Remarks

Concluding Remarks

The “Unofficial The “Unofficial-

• Official” Story

Official” Story

 The “policy mix” became perverse sometime

The “policy mix” became perverse sometime in the mid 2000s: “ in the mid 2000s: “loose fiscal loose fiscal-

• tight money

tight money” ”

 High interest rate differentials high capital

High interest rate differentials high capital

 High interest rate differentials, high capital

High interest rate differentials, high capital inflows, high debt, housing boom, strong inflows, high debt, housing boom, strong currency, currency, tradables tradables stagnation, low savings, stagnation, low savings, high current account deficit, increased high current account deficit, increased high current account deficit, increased high current account deficit, increased vulnerability. vulnerability. l ll f hi i h li i l ll f hi i h li i

 How to solve all of this?: “Fix the policy mix,”

How to solve all of this?: “Fix the policy mix,” plus some additional measures. plus some additional measures. p

Ratio of Ratio of tradables tradables to to non non-

• tradables

tradables GDP GDP

105 110 90 95 100 75 80 85 Series1 65 70 75 60

Assessment Assessment

 The “unofficial

The “unofficial-

• official story” is a consistent and
• fficial story” is a consistent and

compelling narrative compelling narrative

 I agree with most of it with some caveats

I agree with most of it with some caveats

 I agree with most of it, with some caveats,

I agree with most of it, with some caveats, however: however:

d k b i l i b f d k b i l i b f

 We need to know more about certain relations before

We need to know more about certain relations before policy is implemented. policy is implemented.

 Doesn’t pay enough attention to Tinbergen’s and

Doesn’t pay enough attention to Tinbergen’s and Mundell’s Mundell’s principles principles

 Doesn’t ask which policy gives us more “bang for the

Doesn’t ask which policy gives us more “bang for the buck” buck”

 Need to think in an “insurance framework”

Need to think in an “insurance framework”

Main conclusions Main conclusions

 Fiscal is very important, but New Zealand’s

Fiscal is very important, but New Zealand’s problem is problem is not only fiscal not only fiscal.

 As in the old high school exam the correct

As in the old high school exam the correct

 As in the old high school exam, the correct

As in the old high school exam, the correct answer is “ answer is “all of the above all of the above”

 The competitiveness challenge requires micro

The competitiveness challenge requires micro reforms that increase productivity reforms that increase productivity p y p y

 Savings enhancements require focalized

Savings enhancements require focalized policies: policies: KiwiSaver KiwiSaver tax incentives tax incentives policies: policies: KiwiSaver KiwiSaver, tax incentives , tax incentives

 Dealing with vulnerability requires

Dealing with vulnerability requires insrance insrance-

• type

type instruments instruments

Real Exchange Rate Behavior Real Exchange Rate Behavior Real Exchange Rate Behavior Real Exchange Rate Behavior in New Zealand in New Zealand

160

REER_NZ

140 150 130 110 120 90 100 80 90 70 1980 1985 1990 1995 2000 2005 2010

2 4 4 .1 .2 4.3 4.4 .0 4.2

• .1

4.1

• .2

4.0

• .3

3.9

• .4

3.8 90 92 94 96 98 00 02 04 06 08 10 LOG_RELATIVE_P LOG_ERER_TWI14

Empirical Analysis Empirical Analysis y

 The RER in New Zealand behaves similarly to

The RER in New Zealand behaves similarly to th “ dit i ” th “ dit i ”

• ther “commodity currencies”
• ther “commodity currencies”

 No evidence of “collateral damage” from

No evidence of “collateral damage” from g “currency wars” “currency wars”

 Fairly rapid adjustment: in one year more than

Fairly rapid adjustment: in one year more than

 Fairly rapid adjustment: in one year more than

Fairly rapid adjustment: in one year more than 50% of a disturbance is corrected 50% of a disturbance is corrected

 Terms of trade positive shocks lead to

Terms of trade positive shocks lead to appreciation, as expected. appreciation, as expected. pp , p pp , p

 Increase in interest rate differential leads to

Increase in interest rate differential leads to i ti l t d i ti l t d appreciation, also as expected. appreciation, also as expected.

Exercise: Two shocks Exercise: Two shocks e c se: wo s oc s e c se: wo s oc s

 A negative terms of trade shock that reduces

A negative terms of trade shock that reduces commodity prices by 50% would result in a long commodity prices by 50% would result in a long run weakening of New Zealand’s trade run weakening of New Zealand’s trade-

• weighted

weighted g g RER of 16.7%. RER of 16.7%. A d ti i i t t t diff ti l t l l A d ti i i t t t diff ti l t l l

 A reduction in interest rate differentials to a level

A reduction in interest rate differentials to a level equivalent to the (average) Australia equivalent to the (average) Australia-

• US

US differential, results in a long term weakening of differential, results in a long term weakening of New Zealand’s trade New Zealand’s trade-

• weighted RER of 8.6%.

weighted RER of 8.6%. g

 Combined shocks weaken RER by 23.8%.

Combined shocks weaken RER by 23.8%.

International Competitiveness International Competitiveness International Competitiveness International Competitiveness and the Non and the Non-

• Tradables

Tradables Sector Sector

A new indicator: Effective A new indicator: Effective Competitiveness Index Competitiveness Index

 Explicitly takes into account the fact that non

Explicitly takes into account the fact that non tradables tradables (including business and government (including business and government ( g g ( g g services) are used as inputs in production of services) are used as inputs in production of tradables tradables tradables tradables

Productivity levels compared to Productivity levels compared to Australia Australia

160 00% 180.00% 200.00% 100 00% 120.00% 140.00% 160.00% 40 00% 60.00% 80.00% 100.00% 1989-1994 1995-2000 2001-2006 0.00% 20.00% 40.00%

Example Example Example Example

 If non

If non tradables tradables in New Zealand have 70% of the in New Zealand have 70% of the If non If non tradables tradables in New Zealand have 70% of the in New Zealand have 70% of the productivity level in Australia ECI= productivity level in Australia ECI= -

• 0.15%

0.15% S b i i S b i i t d bl t d bl ’ d ti it t ’ d ti it t

 So, bringing non

So, bringing non tradables tradables’ productivity to ’ productivity to Australia’s level implies a Australia’s level implies a gain in gain in competitiveness of 15 percentage points competitiveness of 15 percentage points

 Alternatively a real depreciation of 10%

Alternatively a real depreciation of 10%

 Alternatively a real depreciation of 10%

Alternatively a real depreciation of 10% improves competitiveness in 6.8 percentage improves competitiveness in 6.8 percentage i t i t points points

Some Reflections on Some Reflections on Some Reflections on Some Reflections on Vulnerability Vulnerability

An insurance framework An insurance framework An insurance framework An insurance framework

 Useful to distinguish between

Useful to distinguish between

 Useful to distinguish between

Useful to distinguish between

– “ “self insurance self insurance” mechanisms ” mechanisms – – including the including the d ti f fl ibl li i d ti f fl ibl li i adoption of flexible policies adoption of flexible policies --

• -,

, – “ “market insurance market insurance” mechanisms, ” mechanisms, – and “ and “institutional insurance institutional insurance” mechanisms. ” mechanisms.

Some options to consider Some options to consider So e op o s o co s de So e op o s o co s de

 International reserves

International reserves

 Macro prudential regulations

Macro prudential regulations

 Taxes on capital inflows

Taxes on capital inflows

 Taxes on capital inflows

Taxes on capital inflows

 Bonds indexed to the terms of trade or the

Bonds indexed to the terms of trade or the borrowing spread borrowing spread

 Preapproved swap lines from major central

Preapproved swap lines from major central

 Preapproved swap lines from major central

Preapproved swap lines from major central banks and/or FCL from the IMF banks and/or FCL from the IMF

Conclusions Conclusions