The exchange rate as a price

Over on Rates Blog I’ve knocked up an entry on exchange rates.  In it, I spend a bunch of time just talking about “what an exchange rate is” – all with the aim of turning around and saying that given it is a price, we need to understand what it is telling us and why before we can go off and demand changes.

Effectively, the exchange rate is a symptom of things going on in the real economy – and policy needs to be focused on where these fundamentals may be hit by market and goverment failures, instead of a blanket criticism of the price.  I’d also note that there is a “barrier” to intervention in all this – we do need to actually have a fundamental understand of the issues before we put policy in place.  The persistently high real exchange rate is an issue that has caused some concern (*,*,*) – but “solving” any perceived problem here does not lead us to the conclusion of arbitrarily loosening monetary policy!

Note:  I suspect the comment section over there will look a bit like this – and so will hold off from reading till the weekend.

Update:  Scott Sumner covers similar ground by railing against “imbalances” as a concept – stop concentrating on the price, and start thinking about why the price has shifted.  Lars Christensen reiterates this before both of us.  In some sense, the Lucas Critique stemmed from this very idea.  I genuinely don’t understand why simply saying “let us think of why the price changed, and what the trade-offs are from this fundamental shift (and any policy to change it)” makes people so incredibly angry – but it does!  I have no social skills, and have a passion for discussing trade-offs, so I will never stop making this point – no matter how many nights in bars I have to put up with people yelling at me while I’m drinking my beer 😉

13 replies
  1. Paul Walker
    Paul Walker says:

    I just want someone to explain what a persistently high real exchange rate is. After all if the exchange rate is too high is the price of bread too high and how do we know and more importantly what is the right – not too high or not too low – price of both foreign currency and bread? How is this price to be determined?

    • Matt Nolan
      Matt Nolan says:

      Don’t get me wrong – I purposefully avoid using the word problem and use “issue” and “perceived” as much as I can.

      I believe the view stems from the combination of four views: 1) concern about the persistent current account deficits we face. 2) the fact that the real exchange rate is at the same level as it was in the early 1970’s, with the same terms of trade, but following a weaker relative productivity performance than our trading partners. 3) the relatively high real interest rates that exist in NZ. 4) the low level of measured savings vs investment.

      Of course, all these issues are intrinsically related – they are just stylized facts of NZ over the last 40 years. In of themselves they don’t even constitute a “problem” unless we can identify a market or government failure behind them.

      Which was the point of my article. Instead of yelling at a price (which is perplexing for an economist, but very popular outside of economics), let’s identify the trade-offs that exist in society stemming from private and public actions. Work from there based on societies value judgments.

  2. jamesz
    jamesz says:

    Matt: The Chinese are not the problem, YOU are the problem. You just don’t understand that yet but some meditation will help.

    Everyone: WTF are you talking about, I’m not the damn problem!

    Matt: Hey, how is recommending you meditate on your flaws in any way offensive? We should all be doing that, anyway!

    • Matt Nolan
      Matt Nolan says:

      LOL, no-one is necessarily a problem – it is more a question of asking why things happen in order to both understand what we can do, and what we should do.

      People simultaneously think we can pull a lever and make things better, without truly asking whether we can pull the lever and what the trade-offs are. Reframing and trying to clarify are mechanisms to help everyone, including myself, try to do this 😛

  3. PaulL
    PaulL says:

    So, I’ve been thinking on this post and Eric Crampton’s related post at I intuitively always assume that a high exchange rate benefits exporters (they get paid more) and harms local production. But I hadn’t thought that all the way through. I’ve done some thought experiments here, and I think my conclusion is:
    – A high exchange rate is universally good for the country if you are a price setter – because your exports are worth more in international terms
    – A high exchange rate makes no difference to your terms of trade if you are a price taker, your price in external currency has not changed. However, depending on what happens in your local economy (do locally produced goods get cheaper in local currency terms or stay priced the same) it will alter the distribution of income between different segments of the economy.
    In short, I think this debate is therefore one in which exporters who are price takers are attempting to avoid their incomes reducing relative to the other people in NZ. It isn’t a discussion about NZ v’s the world, it’s a discussion about some special interests wanting a better deal.

    • Matt Nolan
      Matt Nolan says:

      Hi PaulL,

      A higher New Zealand dollar implies that, at a given “global price” and a given “domestic price”, the return to exporters is lower.

      You are right that a higher dollar is a transfer from “net exporters” to “net importers” within a country, and the issue gets complicated by the fact that global and domestic prices change over time – and how relatively scarce different goods and services are changes, in turn changing the price. When we see the dollar bobbing about, it is in turn telling us about how many of these things (which we can’t easily observe) are changing, or how expectations of them are changing.

      As a result, we can’t really say what the “exchange rate” means without a bunch of other assumptions about the cause, it is these causes we should be discussing rather than the dollar itself – that is pretty much all I said. This is a fairly innocuous point in an economists mind, but judging by some of the people I’ve run into in the last week it is not such an innocuous point for everyone … 🙂

Trackbacks & Pingbacks

  1. […] Nolan’s bemoaned that nobody quite seems to understand that exchange rates are just a price. He would love this particular […]

  2. […] Yesterday I read my favourite economics blogger, Eric Crampton, and in particular his article on exchange rates.  He in turn linked to Matt Nolan, with the exchange rate as a price. […]

  3. […] See full story on […]

Comments are closed.