Exchange rate policy

1. Exchange rate policy • NZ government’s exchange rate policy has a significant impact on a nation’s trade. • We have in place a floating exchange rate since 1985 so market forces now set the exchange rate. • Recap…. Answer these questions in pairs • How will these events effect the exchange rate • Demand for NZ exports increase • Demand for overseas imports increase • If you could earn 10% o a savings account in Europe and only 3% on a saving account in NZ • If incomes in the United States were increasing compared with those in NZ.

2. Demand for NZ exports increase - Demand for NZ dollars increases, so NZ dollar appreciates • Demand for overseas imports increase - Supply of NZ dollar increases, so NZ dollar depreciates • If you could earn 10% o a savings account in Europe and only 3% on a saving account in NZ • Demand more Euros, so supply of NZ$ increases, so NZ dollar depreciates • If incomes in the United States were increasing compared with those in NZ - People in the United States could afford to buy more NZ goods and more U.S goods as well. Demand for NZ dollars would go up, and the supply of US dollars would increase in exchange for NZ dollars

3. SLO:-Understand policy responses to unforeseen and external influences and the impact of these policies on trade and growth

4. New Zealand Trade Policy • As a developing country, NZ has pursued the policy of free trade over the past 25 years. • The aim of this is to promote trade between NZ and the rest of the world and having efficient producers competing in international markets in their competitive advantage production. • We have progressively removed barriers to trade (tariffs, quotas, etc), although not completely (e.g. tariffs on some clothing and footwear still exist). • Micro-economic policies also put in place to increase our efficiency of producers • e.g. electricity market reform- targeting reduced energy costs

5. Floating Exchange Rate • This means that the Reserve Bank’s Monetary Policy has a significant impact on the exchange rate. • What tool of the RBNZ will affect interest rates? • OCR

6. RBNZ increases the OCR Interest rates increase Encourages Foreign investment into NZ Demand for $NZ increases (they must invest in NZ banks in NZ currency). $NZ appreciates

7. Trade Policy Responses to unforeseen and external influences • New Zealand is a small country that feels the ripple effects of overseas events. • Natural disasters, wars and Trade agreements that exclude us, all impact on trade. The best we can hope for is to be well placed to take advantage of favourable events and try to insulate ourselves from the full effects of unfavourable events.

8. Favorable Events • •1950 Korean War – increased the demand for wool • http://en.wikipedia.org/wiki/New_Zealand_wool_boom • •Mad cow and foot and mouth disease outbreaks in Europe increased the demand for New Zealand lamb and dairy products. • •Increased world demand for Dairy products from 2006-2007

9. Unfavourable Events • •1970’s oil price shock caused by OPEC • •EEC (later the EU) excluding New Zealand from trade agreements • •2008 international credit crisis • •2009 EU deciding to subsidise farm production meaning European farmers can produce goods at a lower price because they have some of there costs of production covered by the subsidy. This makes NZ products seem more expensive in comparison so we sell less

10. Policy Responses • The NZ Governments free trade policy and agreements with other countries will attempt to counter unfavourable events. • Monetary Policy will be used to counter negative effects of trade on the economy. By increasing the OCR, levels of foreign investment will change causing the exchange rate to change. • A low dollar value will increase exports and decrease imports which is generally seen as a good way for the economy to grow.

11. Impact of Trade Policies • Inflation • An economy such as New Zealand which is open to free trade is also vulnerable to imported inflation. • If the price of imports we depend upon to produce increase eg oil (cost push inflation), then the cost of the products we produce will also increase. • Increased export demand also leads to higher domestic prices eg the price of Dairy products in New Zealand increased dramatically between 2007 and 2008 as world dairy prices rose. • Increased incomes from higher export earnings is also likely to lead to “demand pull inflation” which was also the case in the 2007 – 2008 dairy season.

12. Impact of Trade Policies • Growth • Free trade encourages an economy to produce as efficiently as possible. Any surplus is traded and everyone benefits as was shown in the absolute and comparative advantage examples. This means that through trade (X-M), GDP will increase, this is growth.

13. Activities • Text book page 276 ex 6.25 • Read Case Study page 277 • Text book page 278 ex 6.26