3  Evidence on exchange rate volatility and variability

There is a common perception that New Zealand's exchange rate is very volatile. This section examines the nature of New Zealand's exchange rate volatility and variability and how this compares with other economies, using different measures and frequencies.

The approach to the data

Alternative sources, measures, comparator economies and time periods all give a slightly different picture of movements in the New Zealand dollar. This paper uses four major sources for data:

• Reserve Bank of New Zealand (RBNZ) data on New Zealand's monthly bilateral exchange rates within New Zealand's trade-weighted index;[2]
• Bank of England data on monthly nominal effective exchange rates;
• Bank for International Settlements (BIS) data on monthly nominal and real effective exchange rates; and
• Organisation for Economic Co-operation and Development (OECD) data on monthly real effective exchange rates.

The BIS and OECD series provide the most detailed exchange rate series, by providing high frequency real time series which also take into account third country effects.[3] Effective exchange rates are used where possible as they are the most important from an economy-wide perspective.

Because no one measure can give a complete picture of New Zealand's exchange rate behaviour, different measures of exchange rate volatility and variability are used in this paper:

• In a short-term context the average absolute monthly percentage change is used; and
• In a medium-term context two measures are used to assess the typical amplitude of exchange rate cycles. The first is a high/low analysis[4] over the whole series, and the other is a peak/trough analysis[5] which takes into account all the major peaks and troughs over the sample. The first measure can sometimes be misleading as a measure of variability if a series exhibits a structural change. The second measure is subject to judgement about the timing of the major peaks and troughs of a cycle.

The choice of what economies to compare the variability of New Zealand's exchange rate cycles to and for what time period is ultimately a judgement call. To help avoid a potential bias, this paper includes as many economies as is considered practical. New Zealand's exchange rate is compared against nine economies that have had a floating exchange rate for most of the period analysed, and the focus is on OECD economies. It is worthwhile extending this analysis to a wider group of economies, e.g. South Africa, Chile, Hungary and Taiwan at some point in the future.

Much of the analysis is focused on medium-term variability from the period since 1992. This is the time where most of the economies in the analysis have had floating exchange rates and low and stable inflation.[6] However, for the section on short-term volatility the analysis begins from 1999 as this is when all economies in the sample have floating exchange rates and the Official Cash Rate was introduced in New Zealand.