Reserve Bank On Exchange Rate Volatility And Real Exchange Rate Drivers

This came out a month ago, but this analytical note “New Zealand’s short- and medium-term real exchange rate volatility: drivers and policy implications” is worth a read if you want a solid overview of how the Reserve Bank is thinking about exchange rate volatility.



The macroeconomic balance view of the exchange rate offers a way to interpret exchange rate developments, by identifying a level of the exchange rate that would be consistent with definitions of internal balance (for example, output being at potential or unemployment at its equilibrium rate) and external balance (the current account balance being consistent with convergence to a sustainable long run net foreign debt position).

And that is the hard stuff right there. Intervening without consideration of the trade-off the RBNZ is imposing on the entire economy could be quite horrible. High real exchange rates are a reasonable indicator of healthy investment opportunities in the home country and the ability to obtain goods from overseas at a cheaper price.

This graph is an interesting result of some econometrics work:



As an interesting reminder of why real exchange rates matter, I’d point you to a good IMF article. While real exchange rates do matter, it has to be said that as long as New Zealand government and New Zealand firms can borrow overseas, we’re all good.