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Dollar stirs interventionists

By Neville Bennett

Friday 31st January 2003

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Knives are being sharpened to attack new Reserve Bank governor Alan Bollard. Manufacturers and exporters have been ululating for some time about high interest and exchange rates.

The governor has acted appropriately and fully explained why he has left the official cash rate (OCR) unchanged. This will discomfort some business but also the left-of-centre in government, which favours intervention.

The charge has come from Brian Gaynor, a New Zealand Herald columnist, who led his comment (Jan 25) with a protest against "the inability of the Reserve Bank to respond" to the appreciating dollar. In case the reader missed the first sentence, he later reiterated "Bollard ... was not too concerned about the rising dollar."

Mr Gaynor proceeded to argue the inability of the central bank to intervene "highlights a fundamental flaw in the domestic economy:" namely, "that the export and consumption sectors are almost totally divorced from one another." The solution is "a sustained effort to develop urban-based exports."

Mr Gaynor has opened up a debate on the future direction of the economy. His broadside is a profound attack on free market liberal economics and a disguised call for a return to a socialist command economy.

His solution implies a restriction on imports, a manipulation of exchange and interest rates, possibly a licensing system, and an active regional development programme. There's more: the development of urban-based exports could involve labour direction and training but would usually involve export incentives.

These are preferential facilities for firms that sell their production abroad rather than to domestic consumers. This includes direct subsidies, grants, concessions, tax breaks, special depreciation allowances, export credit insurance at favourable rates and favourable finance. There could be a new export bank to provide long-term credit to overseas customers who buy Kiwi goods and services.

Many in the Labour and Green parties would, of course, welcome this scenario. They have never been comfortable with free market economics and have been openly critical of the prime minister's attempts to extend free trade.

Obviously there are difficulties with New Zealand's current account deficit. Mr Gaynor makes it a central problem: he gives statistics and provides a table of trade data. Exports were down 4.6% in the November year, imports rose 1.1% and a former trade surplus turned into a trade deficit of $1 billion (the trend was continued in the December figures out this week). The implication appears to be that some intervention is necessary.

He makes a pointed contrast using the domestic sector, which has a robust housing market, driven by migration and aggressive bank lending. Retail sales are also buoyant.

Mr Gaynor departs from reporting these trends and asserts "in most other countries a reduction in exports usually has a negative impact on domestic activity" because exporters are spread through the economy, "whereas we are heavily dependent on rural-based commodities." So, unlike Ireland, urban areas do not suffer in international downturn.

This clearly exaggerates the difference between the tradable and non-tradable sector. The exchange rate eases adjustments in the economy between the domestic and international sectors. When the rate moves both sectors have to adjust and the exchange rate is one means by which the price mechanism affects the two sectors.

The exchange rate is a vital component of the price mechanism and is capable of influencing the so-called non-tradable sector.

For example, education is non-tradable but a low dollar attracts more foreign students, makes books more expensive and makes it more difficult to retain and recruit staff.

Yet Mr Gaynor insists on a "disconnection" between the domestic and external sectors, and claims this has been exacerbated by Dr Bollard's refusal to cut interest rates: "As a result New Zealand has some of the highest interest rates in the world."

If policy makers were to act in accord with Mr Gaynor's objective, there would be wholesale intervention in the economy and a whole raft of incentives and controls. And there would be no guarantee of success. Ireland has prospered but policymakers cannot replicate Irish conditions as the EU is unlikely to award New Zealand monstrous subsidies and our trade treaties do not offer us similar protection against external competition.

There is no need for the government to play a greater role in the economy. It may be more beneficial if it did less and also reduced compliance costs. Growth is reasonable at present and it seems broadly sustainable. Certainly there is no crisis.

Dr Bollard's recent Christchurch speech observed the dollar was now around its average level for the last 10 years. He saw no urgency to intervene but recognised the international system was volatile.

In short, he feels the dollar is close to its optimum equilibrium level of 54-60 on the trade-weighted index. The problem about the recent appreciation was essentially its speed, which made life uncomfortable. Access to derivatives gives companies some breathing space to adjust to rapid changes in the exchange rate.

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