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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 by by 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 The Unofficial The Unofficial Official Story: An Official” Story: An Official Story: An Assessment Assessment  How Unique is New Zealand’s Real H How Unique is New Zealand’s Real H U i U i i N i N Z Z l l d’ R d’ R l l Exchange Rate Behavior? Exchange Rate Behavior?  International Competitiveness and the Non International Competitiveness and the Non- - Tradables Tradables Sector Tradables Tradables Sector 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.  How to solve all of this?: “Fix the policy mix,” How to solve all of this?: “Fix the policy mix,” l l ll f hi ll f hi i i h h li li i i plus some additional measures. plus some additional measures. p

Ratio of Ratio of tradables tradables to to non non- -tradables tradables GDP GDP 110 105 100 95 90 85 Series1 80 75 75 70 65 60

Assessment Assessment  The “unofficial The “unofficial- -official story” is a consistent and official 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:  We need to know more about certain relations before We need to know more about certain relations before d d k k b b i i l i l i b f b f 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 “ all of the above answer is “ all of the above ”  The competitiveness challenge requires micro The competitiveness challenge requires micro reforms that increase productivity reforms that increase productivity p p y y  Savings enhancements require focalized Savings enhancements require focalized policies: policies: policies: KiwiSaver policies: KiwiSaver KiwiSaver, tax incentives KiwiSaver tax incentives , 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

REER_NZ 160 150 140 130 120 110 100 90 90 80 70 1980 1985 1990 1995 2000 2005 2010

.2 2 4 4 4.4 .1 4.3 .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 other “commodity currencies” other “commodity currencies” th th “ “ dit dit i i ” ”  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 pp , , p p  Increase in interest rate differential leads to Increase in interest rate differential leads to appreciation, also as expected. appreciation, also as expected. i ti i ti l l t d t d

Exercise: Two shocks Exercise: Two shocks e c se: e c se: wo s oc s 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- g -weighted weighted g RER of 16.7%. RER of 16.7%.  A reduction in interest rate differentials to a level A A reduction in interest rate differentials to a level A d d ti ti i i t i i t t t t diff t diff ti l t ti l t l l l l 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 200.00% 180.00% 160.00% 160 00% 140.00% 120.00% 100 00% 100.00% 1989-1994 80.00% 1995-2000 60.00% 2001-2006 40 00% 40.00% 20.00% 0.00%

Example Example Example Example  If non If non tradables If non If non tradables tradables in New Zealand have 70% of the tradables in New Zealand have 70% of the 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%  So, bringing non S S So, bringing non tradables b i b i i i t d bl t d bl tradables’ productivity to ’ productivity to ’ ’ d d ti it t ti it t 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 points points i t i t

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 adoption of flexible policies adoption of flexible policies -- d d ti ti f fl f fl ibl ibl li i li i --, , – “ “ market insurance market insurance ” mechanisms, ” mechanisms, – and “ and “ institutional insurance institutional insurance ” mechanisms. ” mechanisms.