So ends a choppy year for the dollar

Another year, another wild ride for the New Zealand dollar.

Few, if any, are happy at the fluctuations in the currency, but the limited number of possible solutions seem to face major drawbacks.

As glaring weaknesses in the way money is lent and borrowed, moved and manipulated around the world were laid bare in a scary crisis, proponents of alternatives to the current floating exchange rate may well have gained added credibility.

But their arguments were countered in the late-November report from former Reserve Bank governor Don Brash's 2025 taskforce.

Recommendations from the taskforce, looking at ways to close the income gap with Australia, were given a widespread and resounding raspberry, but the report contains a good explanation of this country's economic woes, including sections on the currency.

``At one level _ but not a terribly helpful one _ it is clear that if a less variable exchange rate could descend from heaven, achieved without changing anything else, the overall performance of our economy (and those of other countries with quite variable exchange rates) would be improved,'' the taskforce said.

It then went on to explain why it did not recommend any change from the current floating rate regime.

Many currencies fluctuated through an ``enormous range'' in 2009, as sentiment on the world economy and attitudes to risky assets waned and waxed, the taskforce said.

``This year has been unusual, although even this year the New Zealand exchange rate has not been at either record highs or record lows.''

Among those showing displeasure with the currency fluctuations was Labour Party leader Phil Goff.

A week or so before the 2025 taskforce came out with its recommendations, Mr Goff told Federated Farmers that Labour was withdrawing from the consensus it had with National over the Reserve Bank's policy targets and tools.

Labour wanted a policy that kept the exchange rate ``as stable and competitive as possible``, he said.

But the Reserve Bank's policy targets were not well designed to produce a stable and competitive exchange rate, nor to keep interest rates as low as possible.

``In fact, it often operates the other way round,'' Mr Goff said.

``When there is a surge in domestic demand, the policy response is to increase interest rates. Ironically, higher interest rates attract even more inflows of foreign capital, which then gets lent out and sometimes causes even stronger domestic demand.

``So New Zealand's overseas debt increases inexorably, while monetary policy punishes our most productive businesses and first home-buyers _ just about the two sectors that we least want to affect.''

A quick glance at the progress of the NZ dollar during the past year or two shows clearly what all the hand wringing is about.

From a high above US82c early in 2008, the kiwi plunged to below US49c in March, before zooming up to a 15-month high around US76.30c in October.

Early this year the kiwi was also down to 0.3874 euro before climbing to a 17-month high 0.5075 euro in October, while against the Australian dollar it fell from near A94c in October 2008, to around A77c in March this year, then by October this year was back up to around A83.75c.

It's enough to give a Reserve Bank governor a migraine, and in September current governor Alan Bollard was warning that business profits were under pressure because of a low level of activity and the ``elevated'' NZ dollar.

If the exchange rate were to continue its recent appreciation and/or recovering house prices were to undermine an improvement in household savings, then the sustainability of the present recovery would be brought into question.

The kiwi did indeed keep rising after that, and by October Dr Bollard was saying, ``the high level of the NZ dollar has limited the scope for exports to contribute to the recovery, and reinforces a bias towards domestic expenditure''.

By early December Dr Bollard was feeling a little more comfortable.

The currency was looking ``a little bit less out of line'' than it had in the past few months, he said. That was due to rising prices for dairy products and other commodities, at the same time as the trade weighted index started to come off a bit.

Any hopes that the global credit crunch may have led to some solution to high levels of currency fluctuation seem to be deflated by Dr Bollard's predecessor and his team in the 2025 taskforce report.

In the wake of the crisis there was new global interest in other ways to dampen future credit cycles, possibly without so much reliance on the official cash rate, and hence without so much pressure on the exchange rate, the taskforce said.

``But it is wise to be cautious at this stage about the potential of these instruments and important to ensure that they are subject to appropriately rigorous regulatory evaluation.''

The taskforce decided the current floating exchange rate regime was likely to be the best ``realistically'' available for this country for now.

That did not inevitably mean New Zealand was facing repeats of the exchange rate peaks of 2007 and 2008, the taskforce said.

``Bad policy _ in particular the very rapid increases in government spending at a period of peak pressure on resources _ helped produce those peaks. But bad policy will produce bad outcomes under any exchange rate system.''

The taskforce did not see a need for a goal of a higher or lower exchange rate for its own sake. Both deeply undervalued and severely overvalued exchange rates skewed the efficient allocation of resources, it said.

It also found the economic literature had a ``surprising'' degree of difficulty isolating the economic impact of exchange rate movements.

- NZPA