For this reason, one needs to ask a different set of empirical questions. Were NZ’s overall outcomes from having monetary independence demonstrably better than other countries? Did monetary policy help cope with exogenous shocks? Was the pattern of shocks different (better/worse) because we had separate monetary policy? I fail to see the evidence on the first. Over the last decade, compared to Australia, we have had higher interest rates on average, similar but on average higher exchange rate fluctuations, inflation that has only been 0.2- 0.3% worse (although bad enough) and no clear pattern that monetary policy has helped us avoid house price cycles or recessions. The interest rate question is vexed, but it seems silly to ignore the fact that interest rates are much higher in NZ than elsewhere. Per capita costs equate to over $10,000 for average family of 4 over a decade: the least that can be said about this number is that isn’t the average Australian family of 4 lucky that they can have monetary policy that delivers similar outcomes to NZ and costs them $10000 less over a decade. Numbers this large suggest it is at least worth asking if indeed NZ has the best possible monetary policy

On the second question, – did NZ’s monetary policy help cope with idiosyncratic shocks – it is necessary to clearly identify the shocks. That is the other problem with using a CGE or DSGE model: the identification of time series macro models is always difficult. One needs incredible faith to believe most identification schemes – which is why time series models are mainly used for forecasting, not structural analysis. (Most economists in other fields (eg labour, development) don’t use these techniques precisely because they don’t believe the identification, and they spend an inordinate amount of time developing datasets/ techniques in which a shock is identified.) But in the last few years there have been some idiosyncratic shocks hitting NZ: two droughts, and the migration boom in 2001/3, for example. So it seems legitimate to ask: did monetary policy help NZ adjust to these shocks? I haven’t studied any of these cases in any depth at all, but as a first stab I would say “Monetary policy wasn’t much help.” Interest rates were raised as the droughts struck, monetary policy wasn’t appreciably tightened to help cope with the migration influx and the resultant housing boom (and there was a stage in 2003 when interest rates were cut before being rapidly increased in 2004). These episodes do need to be explored properly so the empirical question of whether an independent monetary policy actually helps a lot in practice can be answered.

On interest rates: who really knows why they are so high in NZ. It could be a foreign issue: while there is no shortage of foreigners wanting to lend money, they may be a shortage of foreigners wanting to lend in NZ dollars and we might be able to get cheaper loans in a different currency if we used one. Or it could be a domestic issue: the RBNZ clearly controls short term rates, it may simply have chosen to have had very high interest rates over the last 15 years in order to “achieve” its inflation and other (stabilisation) goals. I am not opposed to having moderate interest rates: one of the reasons I admire the RBA so much is precisely because they resisted the international trend of ultra low interest rates in the mid 2000s. But the question still remains: isn’t it unlucky that NZers can’t have a monetary policy that delivers low inflation and a stable economy without having interest rates much higher than elsewhere in the world (in particular Australia), because the current arrangements are very costly. But perhaps, as Dr Pangloss might have said, that is just bad luck; we do live in the best of all possible monetary worlds, and should count ourselves fortunate for having monetary independence, for without it things would have surely been much worse.

Having said that, I like the idea of paying Australian interest rates.

We can’t quite infer that lower rates would have implied looser monetary policy in NZ – because we would have had a stronger currency through the union.

I think the main question we have to ask is how our internal rate of exchange would change. If lower rates drove the housing market on further, and increased non-tradable price pressure, then I suspect that general outcomes would be worse.

However, I have a strong anti currency union bias which I am willing to admit because:

1) I believe exporters are strongly able to hedge against exchange rate risk
2) I believe the exchange rate does compare to some underlying fundamentals, and that these fundamentals are merely more volatile than we would like – and hence lower exchange rate volatility would imply higher price level volatility, something that has a higher welfare cost. [I just realised how much that logic makes me sound like a new classical economist 😛 ]

Even so, I am willing to be turned the other way – given that I recognise there is a trade-off in any currency union situation (hence why Auckland does not have its own currency).

For me it is a question we can only answer empirically.