Singapore monetary policy no model for New Zealand
The Leader of the Opposition, Phil Goff, and some commentators have suggested that the Reserve Bank should exercise more control over the value of the New Zealand dollar. Mention has been made of Singapore's monetary policy, which focuses on controlling the exchange rate. It certainly appears to work well for Singapore with low inflation, relatively low interest rates, good growth, and low unemployment. How much these outcomes are due to Singapore's monetary policy and how much are due to its very low tax rates and levels of government spending, liberal regulatory environment, close proximity to rapidly growing Asian markets, and easy access to cheap migrant labour are arguments for another time. Nevertheless, Singapore's monetary policy can't have harmed its economic performance and it appears to have led to a far less volatile currency than in New Zealand. This confers a significant advantage to its exporters. It has an understandable allure for those who see New Zealand's monetary policy being unduly harsh on our exporters.
However, Singapore's monetary policy model, or even a modified version of it, would not be a good fit for New Zealand. Before explaining why, it is worth clarifying that low inflation is the ultimate objective of Singapore's central bank, the Monetary Authority of Singapore (MAS), just like in New Zealand, Australia, Canada, the US, Britain and many other developed countries. The exchange rate is the MAS's primary tool to achieve low inflation, in the same way that the Reserve Bank of New Zealand uses the Official Cash Rate for this purpose. The MAS aims to manage the trade-weighted exchange rate within certain bands consistent with achieving low inflation, thereby helping smooth the Singapore dollar over economic cycles. The MAS does not seek to influence the long-term trend of the Singapore dollar, the value of which has tended to rise over time.
Admittedly, a less variable exchange rate is a boon for Singaporean exporters. For the Singapore economy as a whole this is particularly advantageous. Its external sector (exports plus imports) accounts for over 200% of GDP. In contrast, New Zealand's external sector accounts for 55% of GDP. Our economy clearly has a much stronger domestic focus than Singapore. Therefore, interest rates are a much more direct and effective way of influencing inflation in New Zealand than the exchange rate. Technically then the Singapore monetary policy model is not a very good fit for New Zealand's circumstances.
Regardless of whether a Singapore-type approach would in theory be desirable for New Zealand, it would be extremely difficult to successfully implement here. The MAS can only follow its policy of managing the exchange rate because it has amassed huge foreign currency reserves currently around $S260 billion (approximately the same in New Zealand dollars). This allows the MAS to credibly influence the value of the Singapore currency over short periods of time because with that much money to play with currency speculators will consider it too risky to take bets against the central bank.
New Zealand currently has around $NZ 14 billion in reserves. At that level the Reserve Bank would have little sway over the New Zealand dollar. The Reserve Bank believes that it can take the tips off the peaks and troughs of cycles in the New Zealand dollar if it is clearly highly over or under-valued, but no more. To have a more substantial effect on the New Zealand dollar the Government would need to give a massive injection to the Reserve Bank's foreign currency reserves money that it simply does not have. Recently the Reserve Bank Governor, Alan Bollard, indicated that currency intervention would not be effective at influencing the value of the New Zealand dollar when its strength is due to underlying weaknesses in major currencies like the US dollar.
One way that the Reserve Bank could have more influence on the currency, which the MAS has practiced intermittently, is to impose controls on the inflow and outflow of capital. This approach is more common among developing countries primarily to maintain financial stability in the face of "hot" money. Such countries have less developed financial systems and economic institutions than more developed countries like New Zealand and, therefore, face larger risks of substantial financial disruptions if big shocks hit their economies. However, capital controls have serious side-effects they raise the cost of borrowing for businesses and inhibit economic growth. History has also shown that capital controls are costly to administer as businesses and currency traders seek ways around them.
New Zealand’s monetary policy model is not perfect, but it better suits our circumstances than the Singapore model. On the whole it has delivered low inflation and less severe business cycles. We should not expect it to be overly focused on smoothing movements in the exchange rate, which is an objective it is ill-suited to achieving.