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New Zealand's Exchange Rate Cycles: Impacts and Policy

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    This paper explores the impact of New Zealand’s exchange rate variability on the tradable sector, and policy options for dampening exchange rate variability. It finds that exchange rate variability in the medium term is likely to have a negative impact on the tradable sector. However, the link between exchange rate variability and the performance of the tradable sector is not automatic; many factors are at work. New Zealand’s tradable and non-tradable sector trends are mirrored in some other countries with varying degrees of exchange rate variability. This suggests that exchange rate variability may explain part of the story as to why New Zealand’s tradable sector has underperformed, but it cannot tell the whole story. This paper recognises the significant negative impact that a sustained high level of the exchange rate can have on the tradable sector. There are no easy or obvious ways to reduce exchange rate variability without some costs. This paper first explores alternative exchange rate regimes, and finds that the freely- floating exchange rate regime is still the most appropriate for New Zealand. Second, this paper explores ways to reduce exchange rate variability within the existing framework. While there are no silver bullets available to reduce exchange rate variability within the existing framework, fiscal policy and housing policy are worth pursuing in this respect, with the possibility for macro-prudential policy to play a small role in stabilising the cycle.

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    File URL: http://www.treasury.govt.nz/publications/research-policy/wp/2011/11-01/twp11-01.pdf
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    Paper provided by New Zealand Treasury in its series Treasury Working Paper Series with number 11/01.

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    Length: 35
    Date of creation: Mar 2011
    Handle: RePEc:nzt:nztwps:11/01
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    Web page: http://www.treasury.govt.nz

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    1. Fabling, Richard & Grimes, Arthur, 2008. "Do Exporters Cut the Hedge? Who Hedges, When and Why?," Occasional Papers 08/2, Ministry of Economic Development, New Zealand.
    2. David Hargreaves & Andy Brookes & Carrick Lucas & Bruce White, 2000. "Can hedging insulate firms from exchange rate risk," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 63, March.
    3. Jonathan David Ostry & Atish R. Ghosh & Karl F Habermeier & Marcos d Chamon & Mahvash S Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
    4. Sergio Nardis & Claudio Vicarelli, 2003. "Currency unions and trade: The special case of EMU," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 139(4), pages 625-649, December.
    5. Sergio Nardis, 2004. "Currency unions and trade: The special case of EMU," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 140(3), pages 625-649, September.
    6. David Hargreaves & C John McDermott, 1999. "Issues relating to optimal currency areas: theory and implications for New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 62, September.
    7. Loretta Fung, 2008. "Large real exchange rate movements, firm dynamics, and productivity growth," Canadian Journal of Economics, Canadian Economics Association, vol. 41(2), pages 391-424, May.
    8. Andrew K. Prevost & Lawrence C. Rose & Gary Miller, 2000. "Derivatives Usage and Financial Risk Management in Large and Small Economies: A Comparative Analysis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(5&6), pages 733-759.
    9. Lynda Sanderson, 2009. "Exchange rates and export performance: evidence from micro-data," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 72, pages 43-52, June.
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