1. No category

Bank regulation, exchange rate
policy, overseas debt, and asset
sales: how to untangle them?
Geoff Bertram
31 March 2011
Preliminary
•
In the real world, market imperfections are pervasive. The history of economics is largely
about analysing the nature of those imperfections and what can be done about them
•
The ‘market efficiency’ paradigm works from the presumption that for practical purposes
real-world markets cannot be improved upon
•
The ‘mixed-economy’ paradigm starts from the presumption that markets won’t do
everything, and even can be improved, and that some things should not be left to the
market mechanism to solve but require collective choice, exercised through politics
•
Market failures quickly become bound up with issues of power: perfect markets would be
democratic in the sense of dispersing power (not of solving distributional questions), but
imperfect markets are all about the exercise of power by some at the expense of others
•
Even perfect markets leave open the question of the ideal distribution of wealth and
income. A fundamental theoretical conclusion of twentieth-century neoclassical
economic theory was that disagreements over distribution could not be resolved by apriori reasoning
Thinking about New Zealand macroeconomics
•
Firstly, if indeed there are fundamental imbalances in the economy as a whole, it is
important to understand how those imbalances have emerged from the interplay of
market forces with policy and social structure, and to think about how policy can key
variables with a long-run perspective
•
Secondly, in thinking about changes that might be made to policy settings, it is
important to explicitly sort out
– what mechanisms you think are at work
– how particular policy changes would be supposed to deliver desired results
– whether there is evidence for the causal mechanisms being appealed to
•
Thirdly, humility is a virtue in an economist. Three cautionary notes:
– It’s seductively easy to overstate the scale and imminence of macroeconomic threats and then engage in
“shock doctrine” arguments for instant radical changes. That’s where Think Big, Rogernomics, and the
current renewed war on the welfare state came from. The essence of the approach is to underplay the
resilience and sustainability of the market economy
– Policies do have long-run effects on the shape of the economy and the distribution of wealth and
income. Once set, those effects are not easy to reverse –institutional incentives and constraints in a
market system are like the forms for concrete (the liquid settles to equilibrium in the liquid short run,
then sets hard in the long run) – so there are real long-run costs and benefits from today’s policies
– I have been one of those worried abut sustainability issues in New Zealand in the era of inflation
targeting and floating exchange rate, and I have been pleasantly surprised by the absence of a
macroeconomic ‘sudden stop’ since 1990. New Zealand did have two sudden stops in the preceding
decades – one in the mid 1970s and one triggered by Rogernomics in the 1980s – but the deregulated
economy has performed better than I expected. Migration has helped a lot, and the bank-facilitated
inflow of capital funds has staved off the transfer problem that I thought possible early last decade.
Those sudden stops did hurt both absolutely and relatively
Eight Settler Economies' Per Capita GDP, 5-year moving averages,
1900-2000
Muldoon
and oil
shocks
Rogernomics
25,000
Argentina
20,000
Chile
Uruguay
Australia
15,000
New Zealand
South Africa
10,000
Canada
USA
5,000
2000
1990
1980
1970
1960
1950
1940
1930
1920
1910
0
1900
1990 Purchasing-Power-Parity US$
30,000
What are the ‘imbalances’ and why have they developed?
•
The current account deficit on the balance of payments, which is bound up with (i) the
evolution of relative prices and the allocation of resources between tradables and nontradables; and (ii) the degree of capital inflow into the economy
•
The ability of deregulated ‘sheltered sectors’ to exercise market power while ‘exposed
sectors’ are unable to do so, which drives part of the relative-price story (capital inflow
drives another part)
•
The external debt, which flows from the current account deficit but itself plays a role in
driving the deficit, via the exchange rate and domestic relative prices
•
The emergence and persistence of a financial sector rife with perverse incentives (i) for
New Zealand households and firms to consume and borrow without facing the external
costs of their decisions; and (ii) for the banks to drive credit expansion on a basis that
looks dodgy (potentially ‘unsustainable’) in the longer run
•
The persistent drive by wealthy private interests to appropriate gains, socialise losses, and
lessen the taxes they face – and the continual weakness of government policy and
regulation in the face of the lobbying pressures these groups command
•
The worsening distribution of income and wealth, both wages/profits, and poor/rich
(closely linked to the political success of neoliberal thinking:
A couple of toy models from old textbooks
• Useful for organising one’s thinking about a small open
economy, used to be taught as central parts of the macroeconomics syllabus, and capture important elements in
how New Zealand economists of the 1960s and 1970s used
to think about macro
• First, the macroeconomic identity that the market economy
delivers ex post in each period
• Second a loanable-funds model to see how the identity
shows up in the balance of payments current account
• Third some implications/consequences of recognising that
output is comprised of two imperfectly-substitutable types
of production: tradable and non-tradable
The macro identity
Disposable
national
income
Y- π ≡ C + I + G + X – M
Domestic
Output
absorption
of goods
Overseas
and
investment
services
income
Trade
balance
(goods and
services)
Rewrites as:
(S – I) + (T – G) ≡ (X - M - cyπ)
Private
savings
Government
savings
≈ Current account surplus
The loanable-funds model at given Y
Interest
rate
S+T
Shifts with income
Equilibrium interest rate
with no capital flows
in
‘World interest rate’
(here local population is
relatively ‘impatient’)
iw
I+G
Units of output
Current account deficit
Sudden stops do happen in the real world
• Intertemporal optimisation models don’t all
imply optimal outcomes!
• Treasury and Bill English have both recently
talked about economic imbalances
Non-tradables
Tradables
Cullen saw the
problem clearly back Cullen then
presided over this
in 2000
English sees the
problem in 2010
From Budget 2010
Why that falling-behind of tradables?
• Possibly a change in the economy’s resource endowment
• More likely a result of economic incentives, i.e. relative prices
• High nominal and real exchange rate squeezes the profitability of
tradables unless their production costs fall rapidly
• Prices moving in favour of non-tradables induce resource
reallocation
• [But note that a lot of non-tradables actually bring foreign exchange
income – services in tourism, education, film production, software
=> there’s a need for more careful decomposition of output data]
Toy model with tradables and non-tradables: Salter-Swan (1950s)
Nontradables
Social indifference
curves
Full equilibrium: internal and
external balance
A
Production possibilities
frontier
Budget line for full
employment, given
relative price ratio
Tradables
What if the price of non-tradables rises relative to the price of
tradables, while internal balance is maintained?
Nontradables
New output combination
New consumption point
New budget line
B
C
A
Original budget line
Trade deficit
Tradables
Conclusion: internal balance is
retained but external balance is not
This leaves the economy with external debt
accumulating over time
Whether that is sustainable, and to what level of
debt, depends on the attitudes of overseas
investors
Another Salter-Swan story: what if overseas capital flows in to buy up
local assets?
Nontradables
New consumption point
D
New budget line at
original relative price
ratio
A
Inflationary excess
demand for nontradables
Original budget line
Trade deficit
Tradables
What happens next? Answer: inflation driven by non-tradables prices until their
relative price rises enough to bring demand and supply into balance at E
Nontradables
Internal balance restored at E
New consumption point F
D
E
F
New budget line at
new relative price ratio
A
Trade deficit
Tradables
Conclusion: internal balance is retained but external
balance is not
This leaves the economy with external debt accumulating over time
Whether that is sustainable, and to what level of debt, depends on the attitudes of
overseas investors
That’s the same as the earlier case of an exogenous shock to non-tradable prices ….
Which story dominates? First is the ‘hoover effect’; second is the ‘overseas takeover’ effect
In the first case, policy would worry about driving down the domestic price ratio (e.g. by
regulating non-tradables prices) to shift resources into tradables, and thus slow down
offshore borrowing
In the second case, policy would look at controlling the capital inflow with an eye on
keeping tradables healthy in case of a sudden stop/transfer problem
If you don’t know which causal mechanism prevails, be ready for both sorts of policy
intervention
So what do the data show?
Take first the inflation-adjusted nominal exchange rate (RBNZ)
http://www.rbnz.govt.nz/keygraphs/Fig8b.html
Trade balance and RBNZ competitiveness 1988-2010
4,000
1.3000
3,000
1.2000
2,000
1.1000
1,000
1.0000
0
Trade balance (LH scale)
0.9000
Competitiveness (RHscale)
-1,000
0.8000
-2,000
0.7000
-3,000
-4,000
1985
1990
1995
2000
2005
2010
0.6000
2015
March years
Trade data from Infoshare; inverted real TWI from RBNZ
But then there’s the Salter-Swan
real exchange rate: the price ratio
between non-tradables and
tradables
In terms of economic structure NZ faces a steady
relative-price swing against tradables
• I have attributed this to the failure to regulate
monopoly utilities which have therefore been able to
push up margins and pass on cost increases, while
tradables producers have been squeezed
• It may also reflect, though, changing relative supply
cost…
• The mechanism is a higher inflation rate for nontradables, which year by year moves prices in their
favour
Geoff Bertram
21
RBNZ, Monetary Policy Statement September 2010 p.2
Geoff Bertram
22
Salter-Swan Real exchange rate: two estimates, 2000=1
1.4
1.2
1
0.8
0.6
0.4
0.2
0
Ratio GDP deflator to import and export prices
Ratio non-tradeables/tradeabbles prices
Sheltered sectors
pulling income from
exposed?
1970Q1
1971Q2
1972Q3
1973Q4
1975Q1
1976Q2
1977Q3
1978Q4
1980Q1
1981Q2
1982Q3
1983Q4
1985Q1
1986Q2
1987Q3
1988Q4
1990Q1
1991Q2
1992Q3
1993Q4
1995Q1
1996Q2
1997Q3
1998Q4
2000Q1
2001Q2
2002Q3
2003Q4
2005Q1
2006Q2
2007Q3
2008Q4
2010Q1
Index, 1970-2010=100
New Zealand Real Exchange Rate: Two Versions
200.0
180.0
160.0
140.0
120.0
Nominal TWI
100.0
NZ/Relative world CPIs
80.0
Real TWI (=Col C / Col E *100)
60.0
Relative price of non-tradeables/tradeables,
March 1988=100
40.0
20.0
0.0
New Zealand Current Account Balance and Merchandise Trade Balance,
annual data 1951-2010
Current account balance LHS
10.0
Trade balance LHS
5.0
% of GDP
0.0
-5.0
-10.0
-15.0
March years
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
1954
1952
1950
-20.0
New Zealand Current Account Balance and Merchandise Trade Balance,
annual data 1951-2010
Current account balance LHS
10.0
3.600
Trade balance LHS
Salter competitiveness RHS
5.0
2.600
% of GDP
0.0
-5.0
-10.0
1.600
-15.0
March years
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
1954
1952
0.600
1950
-20.0
New Zealand Current Account Balance and Merchandise Trade Balance,
annual data 1951-2010
Current account balance LHS
Trade balance LHS
10.0
3.600
Salter competitiveness RHS
RBNZ comoetitiveness RHS
5.0
2.600
% of GDP
0.0
-5.0
-10.0
1.600
-15.0
March years
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
1954
1952
0.600
1950
-20.0
New Zealand Current Account Balance and Merchandise Trade Balance,
annual data 1951-2010
Current account balance LHS
Bretton Woods
10.0
Supply shocks
+
inflation
Float
Trade balance LHS
3.600
Salter competitiveness RHS
RBNZ competitiveness RHS
5.0
2.600
% of GDP
0.0
-5.0
-10.0
1.600
-15.0
March years
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
1954
1952
0.600
1950
-20.0
As external debt rises, the current account gets driven by investment income π
Current account and investment income balance
0
-2000
-4000
-8000
-10000
-12000
-14000
-16000
March years
Current account balance
Investment income debit
2010
2005
2000
1995
1990
-18000
1985
$ million
-6000
http://www.rbnz.govt.nz/keygraphs/Fig6.html
Figure 4.1
The funding of the current account deficit: it’s the banks
$bn
110
$bn
110
Cumulative current account deficits
Cumulative increase in bank's net foreign liabilities
90
90
70
70
50
50
30
30
10
10
-10
-10
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Net International Investment Position (Government plus Private)
160
140
120
80
60
40
20
0
Total Private and Government Net Overseas Liabilities
Banks' net external liabilities
Government Foreign-Currency Liabilities
Government NZD liabilities held offshore
2010
2000
1990
1980
1970
1960
1950
1940
1930
1920
1910
-20
1900
% of GDP
100
Net International Investment Position (Government plus Private)
160
140
120
80
60
40
20
0
Total Private and Government Net Overseas Liabilities
Banks' net external liabilities
Government Foreign-Currency Liabilities
Government NZD liabilities held offshore
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
-20
1988
% of GDP
100
Who owes what exactly to whom?
• It’s not helpful to just say “we” or “the country” are in debt or
overextended.
• The fact is that NZ residents basically owe the banks sums in NZD, with no
exchange rate exposures
• The banks are sitting on $318 billion of NZD assets funded by $96 billion of
foreign currencies and $230 billion of NZD liabilities
• The long-run worry for the banks is of capital losses in the event of
depreciation: the NZD claims are collectible in NZD; the foreign-currency
liabilities will revalue upwards if the NZD exchange rate falls
• This is not the hedging issue as usually understood – it’s a longer-run
balance sheet mismatch
Consolidated Balance Sheets of the Banks January 2011
Liabilities, capital and reserves
Jan-11
NZ dollar funding
1 NZ resident
2 Non-resident
3 Total 1+2
Assets
Jan-11
NZ dollar claims
192.4
37.9
230.3
Foreign currency funding
NZ resident (non-M3)
Non-resident
Sub-total to here
297.8
7.1
304.9
NZ resident (M3 institutions)
Total
12.9
317.8
Foreign currency claims
4 NZ resident
5 Non-resident
6 Total 4+5
7.2
88.5
95.7
NZ resident
Non-resident
Total
7 Capital and reserves
8 Other iabilities
22.8
28.8
Foreign-currency fixed assets
Shares in NZ companies
Other assets
0.1
0.2
30.2
Government bonds
NZ nots and coin
Claims on the Reserve Bank
5
0.6
7.1
Total labilities
Memo items:
funding from associates
total non-resident funding
377.6
Total assets
43.2
126.4
Memo items:
financial claims on associates
total non-resident claims
3.6
4
7.6
377.6
5.5
11.1
Equity International Investment Position
80,000
60,000
40,000
20,000
Equity assets
0
Equity Liabilities
Net International Equity
-20,000
-40,000
Dec-10
Jun-10
Dec-09
Jun-09
Dec-08
Jun-08
Dec-07
Jun-07
Dec-06
Jun-06
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Dec-02
Jun-02
Dec-01
Jun-01
Dec-00
-80,000
Jun-00
-60,000
-200,000
Nov-10
Jun-10
Jan-10
Aug-09
Mar-09
Oct-08
May-08
Dec-07
Jul-07
Feb-07
Sep-06
Apr-06
Nov-05
Jun-05
Jan-05
Aug-04
Mar-04
Oct-03
May-03
Dec-02
Jul-02
Feb-02
Sep-01
Apr-01
Nov-00
Jun-00
Banks International Investment Psition
100,000
50,000
0
-50,000
Bank loan assets
Banks liabilities
Banks net position
-100,000
-150,000
Government International Loan Position
20,000
10,000
0
General government assets
-10,000
General government liablities
Government net
-20,000
Dec-10
Jun-10
Dec-09
Jun-09
Dec-08
Jun-08
Dec-07
Jun-07
Dec-06
Jun-06
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Dec-02
Jun-02
Dec-01
Jun-01
Dec-00
-40,000
Jun-00
-30,000
Other sectors International Loan Position
40,000
20,000
0
-20,000
Other sectors assets
Other sectors liablities
-40,000
Other net
-60,000
Dec-10
Jun-10
Dec-09
Jun-09
Dec-08
Jun-08
Dec-07
Jun-07
Dec-06
Jun-06
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Dec-02
Jun-02
Dec-01
Jun-01
Dec-00
-100,000
Jun-00
-80,000
But there has been a break in the
trend since the 2008 crisis
(The interesting question domestically is
whether the economy has saturated its demand
for credit – i.e. whether deleveraging will
continue for the next few years regardless of
inducements to borrow)
-5
-10
-15
Oct 2010
Jun 2010
Feb 2010
Oct 2009
Jun 2009
Feb 2009
Oct 2008
Jun 2008
Feb 2008
Oct 2007
Jun 2007
Feb 2007
Oct 2006
Jun 2006
Feb 2006
Oct 2005
Jun 2005
Feb 2005
Oct 2004
Jun 2004
Feb 2004
Oct 2003
Jun 2003
Feb 2003
Oct 2002
Jun 2002
Feb 2002
Oct 2001
Jun 2001
Feb 2001
Oct 2000
Jun 2000
% change in credit outstanding by sector, June 2000 to January 2011
30
25
20
15
Agriculture
10
Business
Housing
Consumer
5
TotalHousehold
Total Credit
0
0.0
Jan 2011
Sep 2010
May 2010
Jan 2010
Sep 2009
May 2009
Jan 2009
Sep 2008
May 2008
Jan 2008
Sep 2007
May 2007
Jan 2007
Sep 2006
May 2006
Jan 2006
Sep 2005
May 2005
Jan 2005
Sep 2004
May 2004
Jan 2004
Sep 2003
May 2003
Jan 2003
Sep 2002
May 2002
Jan 2002
Sep 2001
May 2001
Jan 2001
Sep 2000
May 2000
Jan 2000
$billion
Credit outstanding by sector
350.0
300.0
250.0
200.0
Consumer
Housing
150.0
Business
Agriculture
100.0
50.0
Funding the growth of NZ dollar assets of the banks and M3 institutions
March 1988 - Jan 2011
350,000
300,000
250,000
Total NZD assets, M3 institutions
Total NZD assets, registered banks
200,000
$ million
Total NZ dollar funding, M3 institutions
Total NZ dollar funding, registered banks
NZ resident NZD funding, M3 institutions
150,000
NZ resident NZD funding, registered banks
Total foreign currency funding, M3 institutions
Total foreign currency funding, registered banks
100,000
Funding from associates, M3 institutions
Funding from associates, registered banks
50,000
Sep 2010
Nov 2009
Jan 2009
Mar 2008
May 2007
Jul 2006
Sep 2005
Nov 2004
Jan 2004
Mar 2003
Jul 2001
May 2002
Sep 2000
Nov 1999
Jan 1999
Mar 1998
May 1997
Jul 1996
Sep 1995
Jan 1994
Nov 1994
Mar 1993
May 1992
Jul 1991
Sep 1990
Nov 1989
Jan 1989
Mar 1988
0
Back in 2009 I was worrying about the rapidly growing gap
Funding of NZ banks, March 1988-September 2008
350,000
300,000
$58B
250,000
200,000
150,000
100,000
NZD claims on NZ residents, M3 institutions
NZD claims on NZ residents, registered banks
Total NZD funding, M3 institutions
Total NZD funding, registered banks
NZD funding from NZ residents, M3 institutions
NZD funding from NZ residents, registered banks
Nov 2010
Mar 2010
Jul 2009
Nov 2008
Mar 2008
Jul 2007
Nov 2006
Mar 2006
Jul 2005
Nov 2004
Mar 2004
Jul 2003
Nov 2002
Jul 2001
Mar 2002
Nov 2000
Mar 2000
Jul 1999
Nov 1998
Mar 1998
Jul 1997
Nov 1996
Mar 1996
Jul 1995
Nov 1994
Jul 1993
Mar 1994
Nov 1992
Mar 1992
Jul 1991
Nov 1990
Mar 1990
Jul 1989
0
Nov 1988
50,000
Mar 1988
NZ$ million
$98B
Three years on, it’s virtually frozen
Funding of NZ banks, March 1988 - January 2011
350,000
October 2008
300,000
$67B
250,000
NZ$ millions
$105B
200,000
150,000
100,000
NZD claims on NZ residents, M3 institutions
NZD claims on NZ residents, registered banks
Total NZD funding, M3 institutions
Total NZD funding, registered banks
NZD funding from NZ residents, M3 institutions
NZD funding from NZ residents, registered banks
Nov 2010
Mar 2010
Jul 2009
Nov 2008
Mar 2008
Jul 2007
Nov 2006
Mar 2006
Jul 2005
Nov 2004
Mar 2004
Jul 2003
Nov 2002
Mar 2002
Jul 2001
Nov 2000
Mar 2000
Jul 1999
Nov 1998
Mar 1998
Jul 1997
Nov 1996
Mar 1996
Jul 1995
Nov 1994
Mar 1994
Jul 1993
Nov 1992
Mar 1992
Jul 1991
Nov 1990
Mar 1990
Jul 1989
Nov 1988
0
Mar 1988
50,000
Meantime the Core Funding
Requirement has begun to shift
the maturity structure of bank
funding
Banks' foreign-currency funding by maturity
120000
B8.9 5 +
B8.8 4 years < 5 years
100000
B8.7 3 years < 4 years
80000
B8.5 1 year < 2 years
60000
B8.4 90 days < 1 year
B8.3 2 < 90 days
40000
B8.2 Other call
20000
B8.1 Transaction call
Wholesale guarantee start and end
Dec 2010
Sep 2010
Jun 2010
Mar 2010
Dec 2009
Sep 2009
Jun 2009
Mar 2009
Dec 2008
Sep 2008
Jun 2008
Mar 2008
Dec 2007
Sep 2007
Jun 2007
Mar 2007
Dec 2006
Sep 2006
Jun 2006
Mar 2006
Dec 2005
Sep 2005
Jun 2005
Mar 2005
0
Dec 2004
$ million
B8.6 2 years < 3 years
Foreign-currency funding under
Wholesale Guarantee
Banks' foreign-currency funding by maturity: % breakdown
100%
90%
80%
70%
B8.9 5 +
60%
B8.8 4 years < 5 years
B8.7 3 years < 4 years
50%
B8.6 2 years < 3 years
B8.5 1 year < 2 years
40%
B8.4 90 days < 1 year
B8.3 2 < 90 days
30%
B8.2 Other call
B8.1 Transaction call
20%
10%
0%
One black mark in the picture is the
Wholesale Deposit Guarantee, which has
made $10 billion of bank borrowing a
taxpayer liability, with $8.5 billion owed in
foreign currency, mainly USD
That’s 6% of the banks’ gross foreign
currency liabilities for which the exchange
risk has been passed to society
0
Jan-09
Mar-09
May-09
Jul-09
Sep-09
Nov-09
Jan-10
Mar-10
May-10
Jul-10
Sep-10
Nov-10
Jan-11
Mar-11
May-11
Jul-11
Sep-11
Nov-11
Jan-12
Mar-12
May-12
Jul-12
Sep-12
Nov-12
Jan-13
Mar-13
May-13
Jul-13
Sep-13
Nov-13
Jan-14
Mar-14
May-14
Jul-14
Sep-14
Nov-14
NZ $ million
New Zealand Wholesale Deposit Guarantee Scheme Liabilities
12,000
10,000
8,000
Kiwibank
6,000
Westpac
ANZ
4,000
BNZ
2,000
0
Nov-14
Sep-14
Jul-14
May-14
Mar-14
Jan-14
Nov-13
Sep-13
Jul-13
May-13
Mar-13
Jan-13
Nov-12
Sep-12
Jul-12
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
NZ $ million
New Zealand Wholesale Deposit Guarantee Scheme Liabilities by Currency
12,000
10,000
8,000
Yen
6,000
AUD
USD
4,000
NZD
2,000
So can we be sanguine?
•
No, because at some point economic activity will pick up again and at that point the debt buildup
could resume unless the banks are restrained or NZ households and businesses decide to operate
within their current income
•
Also no because there is a big inflow of offshore funds from reinsurance coming up after the
Christchurch earthquake, which will tend to hold the nominal exchange rate up and put pressure on
domestic non-tradables prices
•
The RBNZ’s response to the latter will be to raise the OCR, reinforcing the exchange rate overvaluation
and rewarding carry traders while putting financial stability again in jeopardy
•
There’s definitely a need for something extra in the policy mix
•
The Core Funding Ratio is a big step in the right direction but does not address currency mismatch in
the banks’ balance sheets – only the extent of exposure to maturity mismatch
•
Over time it would be good to see the currency mismatch unwound, at least to some target level low
enough to be free of concern about external debt sustainability
•
There is also a good case for restricting hot money flows by some variant of a Tobin tax or other
regulatory capital controls
•
One way to shift the policy focus in that direction would be to explicitly widen the RBNZ’s objectives
to include some notion of exchange rate targeting, both real and nominal
•
[That was the key role assigned to the ‘Bank’ in Salter’s original paper – he assigned fiscal policy to
deal with inflation!]
What about government debt?
Breakdown of New Zealand Government Debt
300
250
Unspecified gross debt
NZD government securities on
issue
150
Gross foreign-currency debt
100
NZD debt held offshore
Net foreign-currency debt
-50
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
1945
1940
1935
1930
1925
1920
1915
1910
0
1905
50
1900
% of GDP
200
Breakdown of New Zealand Government Debt
70
60
50
Unspecified gross debt
NZD government securities on
issue
30
Gross foreign-currency debt
20
NZD debt held offshore
10
-10
-20
2010
2005
2000
1995
0
Net foreign-currency debt
1990
% of GDP
40
What does that mean for fiscal policy?
• First, there is a lot of headroom for borrowing
• Second, there are really interesting analytical questions
about the ways in which (and extent to which) changes
in spending and the fiscal balance work their way
through (i) to income (hence S and T) via Keynesian
channels, or (ii) diretly to the current account (X-M-π)
via financial-market channels
• Third, state asset sales will draw in offshore funds,
pushing the nominal exchange rate up and weakening
the International Investment Position – perverse from
the point of view of helping to raise savings
A couple of lessons for macro policy
• Prices matter in a market economy => price distortions produce
distortions in economic structure
• The RBNZ needs multiple instruments to achieve multiple
objectives – or some other agency has to take on the issues that the
OCR cannot touch
• Inflation targeting causes a lot more collateral damage than its
advocates usually acknowledge, in terms of real exchange rate
impact of the interest rate
• Setting out deliberately to move the exchange rate down by, e.g.,
regulating bank balance sheets, has an obvious downside: it drives
up the prices of tradables and hence reduces real wages in terms of
consumption goods insofar as household budgets contain more
tradables than nontradables.