3.1 Short-term (month-to-month) volatility
Comparisons with other economies suggest that New Zealand is one of a few economies who have all experienced high short-term exchange rate volatility over the previous decade. Figure 4 shows that New Zealand, Australia and Japan all face the highest levels of short-term volatility out of the economies included in the analysis.[7]
- Figure 4: Real effective exchange rate volatility (January 1999 to August 2010)
- Source: Bank for International Settlements, OECD (Consumer Price Index deflated[8]), author's calculations
Note: Figure ordered by BIS rankings. Source:
Across the currencies that make up the New Zealand TWI there is considerable disparity in the volatility of the various bilateral exchange rates (figure 5). At the firm level, it is these bilateral exchange rates that are likely to be most important.
- Figure 5: Nominal bilateral exchange rate volatility (January 1999 to September 2010)
- Source: Reserve Bank of New Zealand, authors calculations
Note: TWI weights shown above were set in December 2009. New weights take effect on 16 December 2010.
The NZD/AUD bilateral exchange rate is one of the more stable cross rates globally (out of economies who float their exchange rates (2025 Taskforce, 2009). The NZD/USD bilateral exchange rate is the second most volatile in New Zealand's TWI, largely reflecting the major differences in the two economies and the fact that the US dollar is itself volatile. The NZD/JPY is the most volatile bilateral exchange rate in New Zealand's TWI, but Japan only makes up 15% of the TWI. Figure 6 shows a longer history of the New Zealand dollar against the British pound, US dollar and the Australian dollar.
- Figure 6: Bilateral nominal exchange rates (monthly data, June 1973 to September 2010*)
- Source: Reserve Bank of New Zealand
*Data available from 1973 only.
Commentators often assess New Zealand's exchange rate volatility relative to others using the US dollar as the common term. In comparisons of economies' bilateral exchange rates with the US dollar, this paper finds that the New Zealand dollar is the most volatile (figure 7).[9] The United States makes up the largest part of New Zealand's TWI. Around 17% of New Zealand's trade goes to the United States.[10] While this is significant and will be important for individual exporters, the TWI is a better indicator of economy-wide exposure to exchange rate movements. While the US dollar does make up the largest part of New Zealand's TWI, it only counts for 29% of it, explaining why the NZD/USD is more volatile than New Zealand's TWI (see figure 5). Box 2 explains why movements in the currency of denomination in trade may not have a significant impact on exporters in the medium term.
- Figure 7: Nominal exchange rate volatility against the US dollar (January 1999 to September 2010)
- Source: Bank of England, author's calculations
Box 2: The importance of the currency of denomination
A significant portion of New Zealand's trade is denominated in US dollars. When this occurs, short-term movements in the NZD/USD exchange rate are likely to have a significant impact on New Zealand dollar export receipts. However, in the medium term the exchange rate that actually matters is that between New Zealand and the regions that ultimately consume the traded goods.
To illustrate and explain this point, consider a stylised example. Europeans are the only consumers of milk powder and they are willing to pay US$4,000 per tonne for it, the EUR/USD exchange rate is 1.30 and the NZD/USD is 0.70. At these exchange rates, a New Zealand exporter of milk powder would receive NZ$5,714 per tonne of milk powder sold. Imagine that the US dollar depreciated by 10% against all currencies. In the short-term, New Zealand export receipts would fall by 10% (to NZ$5,195).
However, because the euro price of milk has decreased considerably, demand for New Zealand milk powder from European consumers will increase. As supply is likely to be constrained in the medium-term, this increase in demand will push up the US dollar price by 10% (in reality the price increase would likely be slightly less than 10%). New Zealand exporters would now receive NZ$5,714 per tonne of milk powder sold. The increase in the US dollar price in the medium-term, along with the depreciation of the US dollar against the Euro and New Zealand dollar, leaves New Zealand exporters with the same amount of export receipts as before the original depreciation of the US dollar occurred.
The results above can be sensitive to the start and end points of the series. To explore this, some of the analysis above has been replicated using the BIS monthly real effective exchange rate series, but using start points of 1992 and 1964.[11] The analysis above has also been replicated using an end point of 2007. For the time period 1992 to 2010 and 1964 to 2010 the results do not materially change despite affecting the ordering of a few economies, except that New Zealand looks considerably less volatile. When the time period 1999 to 2007 is examined similar results are found to those shown in figure 3.
Data in the charts above is also used to explore how New Zealand's real effective exchange rate volatility differs from economies with different currency regimes. Figure 8 shows that the real exchange rate of economies that are part of a currency union, the euro, or that target a particular rate against a basket of currencies, can and do fluctuate, though not as much as economies with floating exchange rates. An economy that fixes its exchange rate to another currency can only achieve stability against that one currency, which will fluctuate against other currencies. Also, an economy can only fix its nominal exchange rate, and has less influence over the real exchange rate. The real exchange rate is influenced by relative price movements, which depend on a range of factors that cannot be controlled. Furthermore, if the exchange rate cannot act to absorb macroeconomic volatility, then it will emerge elsewhere in an economy, e.g. economic growth rates and unemployment rates (Mabin, forthcoming).
- Figure 8: Real effective exchange rate volatility: different exchange rate regimes (January 1999 to September 2010)
- Source: Bank for International Settlements, author’s calculations
Note: Bars in green reflect economies that have mostly been part of a currency union, the euro, or that have targeted a particular rate against a currency or a basket of currencies for most of the period analysed. Bars in blue reflect economies that have had floating exchange rates for most of the period analysed.
Notes
- [7]This analysis has been repeated using nominal data from both the BIS and the Bank of England. The nominal results are consistent with the real data (although the rankings do change slightly). These results are also consistent with the same analysis using daily data (2025 Taskforce, 2009).
- [8]The OECD provides two real effective exchange rate series, one with the Consumer Price Index as the deflator and the other with unit labour costs in manufacturing as the deflator. This latter measure can provide a better measure of the competitiveness of an economy, but it does have some drawbacks, including issues of different measurement between countries. The analysis has been replicated using the OECD's quarterly unit labour cost deflated series. Using this data, the same group of economies appear at the upper end of exchange rate volatility.
- [9]The exact same results are found using the Bank of England's nominal series of bilateral exchange rates against the US dollar over the same timeframe. The Bank of England series includes the euro, and the volatility of the euro against the US dollar sits in the middle of the group in figure 5.
- [10]For information on the changing nature of New Zealand’s trade flows see Zhang (2009).
- [11]1992 is chosen because it is when most economies in the analysis have floating exchange rates and low and stable inflation. 1964 is chosen because of data availability.
