3.2  Medium-term variability

Although an economy may have a volatile currency on a short-term basis, this need not necessarily result in large exchange rate cycles. New Zealand has only experienced a small number of cycles since the dollar was floated in 1985. This makes drawing firm conclusions from the data challenging, and the comments that are made in this section are made with the caveat of this limited data.

Available evidence suggests that New Zealand has a considerably variable exchange rate, and even though different measures suggest different degrees of variability, other relevant economies also face high variability.

Figure 8 shows the ranges within which the various exchange rates have fluctuated over the past 18 years (high/low analysis). While being a simple measure, it has the advantage that it gives us an indication, absent any judgement, of how variable New Zealand's exchange rate has been compared to other economies. Figure 9 shows that New Zealand has a similar degree of variability to Australia, Canada, the Euro Area, Sweden and South Korea.[12] Over that period, the high in the real value of the New Zealand TWI in 1997 was almost 60% above its low in 2000.

Figure 9: Real effective exchange rate amplitude: high/low analysis (monthly data January 1992 to September 2010)

Source:  Bank for International Settlements, author’s calculations

Note: The range is based on two data points. The average and the September 2010 figures used in this figure are presented in percentage form relative to the minimum value of the series. Data for South Korea and the Euro Area are taken from mid-1998 and 1999 respectively.

The high/low analysis can miss important information about the size of different cycles, and can be influenced by changes in equilibrium levels of exchange rates (see Section 4.2 below). Because of this, the high/low analysis should be seen in conjunction with a more robust peak/trough analysis. While this latter technique captures more information, a disadvantage is that there are no hard-and-fast rules defining the peaks and troughs of a cycle; it relies on judgement in deciding where the peaks and troughs of the cycle are.[13]

The peak/trough analysis (figure 10) shows a similar result to the high/low analysis: New Zealand does face considerable variability in its exchange rate, but so do some other relevant economies. Looking across both measures, New Zealand, Australia, Japan and South Korea consistently appear as the economies with the most variable exchange rates. Depending on the measure used, Sweden and the Euro Area also appear to have highly variable exchange rates.

Figure 10: Real effective exchange rate amplitude: peak/trough analysis (monthly data, January 1992 to September 2010)

Source:  Bank for International Settlements, author’s calculations

Note: See footnote 5 for an explanation of how the weighted average is calculated. Data for South Korea and the Euro Area are taken from mid-1998 and 1999 respectively.

Table 1 presents the data used in the peak/trough analysis, and figure 11 shows the movements in each economy's real effective exchange rate. The table shows the turning points identified for each economy, and the duration (in months) of each peak (trough) to trough (peak). The table shows that the New Zealand dollar's peak-to-trough phases have been shorter than the one trough-to-peak phase experienced. This trough-to-peak phase has been the largest of the economies in the table, and very similar to the phase Australia experienced at around the same time. This is clearly shown in figure 11. Both South Korea and Japan have experienced larger peak to trough phases than New Zealand.[14] South Korea, Japan, the Euro Area (based on one trough-to-peak phase), Australia, Canada and New Zealand all experienced relatively long cycles over the period analysed.

Table 1: Amplitude and duration of real effective exchange rate cycles (monthly data, January 1992 to September 2010)

	Peak	Trough	Amplitude* (months duration in parentheses)				Average Amplitude – all turning points
			Peak to trough		Trough to peak
Example							35.0
Switzerland	Nov-95	Mar-00	18.3	(52)	10.2	(34)
	Jan-03	Oct-07	13.0	(57)			13.8
Sweden		Apr-95			14.2	(18)
	Oct-96	Sep-01	26.5	(59)	13.2	(51)	18.7
	Dec-04	Mar-09	20.9	(39)
United Kindgom		Jul-95			26.2	(57)
	Apr-00	Aug-03	11.9	(40)	8.7	(41)	19.4
	Jan-07	Jan-09	30.8	(24)
United States		May-95			28.7	(81)
	Feb-02	Mar-08	28.8	(73)	17.6	(12)	25.0
	Mar-09
Canada		Nov-01			41.0	(72)
	Nov-07	Mar-09	22.6	(16)			31.8
Australia		Sep-93			22.8	(42)
	Mar-97	Mar-01	27.6	(48)	43.8	(88)	30.1
	Jul-08	Dec-08	26.3	(5)
New Zealand	Mar-97	Oct-00	39.0	(43)	44.6	(81)
	Jul-07	Feb-09	31.0	(19)			38.2
Japan	Apr-95	Aug-98	45.5	(40)	28.9	(20)
	Apr-00	Jul-07	47.9	(87)	35.8	(18)	39.5
	Jan-09
Euro Area		Oct-00			41.7	(93)	41.7
1999 →	Jul-08
South Korea		Jun-98			40.4	(109)
mid-1998 →	Jul-07	Feb-09	43.3	(19)			41.8

* The figures in these columns are the respective weighted averages of each phase e.g. peak to trough (see footnote 5 for an explanation of how this is calculated). The economies are listed in order of the lowest to highest average amplitude.

Source: Bank for International Settlements

Figure 11: Real effective exchange rates (monthly data, January 1992 to September 2010, all in indexed form)

Source:  Bank for International Settlements

The data analysed so far suggests that New Zealand has similar exchange rate cycles to Australia and the two real exchange rate series appear to experience similar medium-term variability (figure 12). The stronger terms of trade that Australia has experienced recently can explain part of the divergence in the level of the exchange rate over the previous four years.

Figure 12: Australia and New Zealand's real effective exchange rate variability (monthly data, September 1963 to September 2010)

Source:  Bank for International Settlements

Who should New Zealand be compared with?

This paper has shown that the high variability of New Zealand's exchange rate cycles appears to be similar to several economies. But are these economies the right comparators? There are some reasons to suspect that for New Zealand, medium-term exchange rate variability may matter more than for other economies.

Canada is a commodity exporter like New Zealand, but its larger size and its proximity and access to the United States market means that not only does it have a large domestic market, but also a large neighbour with which it has a relatively stable exchange rate. Sweden and the United Kingdom are similar in this regard, having all of Europe at their doorstep. Japan has a very different economy from New Zealand's, with a larger manufacturing sector. South Korea is not commodity based and it has access to a wide range of fast growing markets in very close proximity. Australia may be the closest comparator economy, in that it is relatively small and faces a similarly long distance to markets, but it has a larger domestic market than New Zealand and there is a predominance of mining in its composition of exports.

Given New Zealand's small size, exchange rate variability may be more damaging for New Zealand than for other economies. The impact of the exchange rate on New Zealand's exporters and wider economy will be discussed in Mabin, forthcoming.

Conclusions on the evidence

New Zealand experiences a volatile exchange rate over short-term horizons. The volatility of bilateral exchange rates shows considerable variation across New Zealand's major trading partners.

The number of exchange rate cycles since New Zealand's exchange rate was floated is limited, and the measures this paper has used to assess medium-term variability are not perfect. To counter this, many sources, measures, time periods and comparator economies have been used. The data points to the conclusion that New Zealand experiences large exchange rate cycles, but that this is common to several other relevant economies.