Careful discussing a “dollar policy”

I see there are further calls for NZ to look at its “dollar policy”.  I do not believe that an investigation will sensibly suggest we should change much in terms of “direct” policy – and I think it is important to try and understand what is going on here before saying we shoudl control anything.

Remember, the relative value of the dollar (the exchange rate) is really just a “price” we have for swapping currency and to buy goods and services (and the such) off each other.  Like any price we need to determine “what is the market failure” before we mess around with it – the default “policy” IS to not interfere, we need a well articulated market failure that we feel we can deal with in a favourable way.

Now, the failure that gets identified here is “dutch disease” (or as I like to term it, the dutch issue).

It is UNDENIABLE that the rising terms of trade has pushed up the real exchange rate.  However, whether the change in relative prices that has occurred in the economy is a negative or positive IS NOT clear.  In fact, the default argument would really be that it is a GOOD thing.  [FYI, I would suggest reading this for a discussion around the evidence – and policy relevance – of “dutch disease”]

Manufacturers complain about the fact that they are less competitive – which is true.  However, as a country we have a comparative advantage at making something that the world values – as a result we want resources to move away from manufacturers in industries that are not part of the industry that is experiencing higher prices.  As technology, tastes, desires, preferences, populations, and the allocation of resources all change in the global economy we want to be able to respond to changes in scarcity – changes in price.  It is BAD to try and keep the structure of the economy the same and not allow adjustment – lets not forget about the Muldoon era.

Now you might think you are very clever, and you might say “aha, but what about if the price increase is temporary, and people invest too much, and then we lose our manufacturing and sell lots of worthless commodities”.  My response would be to say – people are reacting to expected changes in prices in the future, as they are investing.  There are solid reasons why commodity prices will stay “on average” higher then they have, and people in all industries are responding to that expectation – unless we think everyone is stupid, and that government knows better about the future, there is no case for intervention.

To me this implies there is no case for intervention.  Sadly for some people, this is the real case they have in their heads for intervention :(

Note:  This is not to say that, in the face of a massive change in the terms of trade, there is no role for monetary and fiscal policy to improve outcomes – after all, it is a clearly recognisable shock, and the cyclical and distributional consequences of it can be dealt with using policy.  However, it is to say that directly f’ing around with our exchange rate in order to “help manufacturers” is likely to be bad policy – based more on a status quo bias among people than on sensibly policy design.