4.3 Conclusions on the impact of exchange rate fluctuations
The previous section showed that New Zealand's tradable sector performance relative to its non-tradable sector has been weaker than the top performers, but similar to that in several other relevant countries. Theory suggests that New Zealand's exchange rate volatility and variability negatively impact on exporters and those that compete directly or indirectly with imports. But the hard evidence for this is limited. Some recent empirical evidence for New Zealand suggests there are negative effects of exchange rate volatility and variability at the firm level, but there is no clear evidence that it results in a reduction in aggregate exports. The ability of firms to hedge short-term volatility means that this paper concentrates on the effects on medium-term variability. It is likely that high exchange rate variability may matter more for New Zealand than for other countries.
It appears that the link between exchange rate variability and the performance of the tradable sector is not automatic; many other factors are at work. The fact that New Zealand's tradable and non-tradable sector trends are mirrored in some other countries suggests that exchange rate variability may explain part of the story as to why New Zealand's tradable sector has underperformed, but that it cannot tell the whole story. This paper does recognise the significant negative impact that a sustained high level of the exchange rate can have on the tradable sector.
Because it is difficult to know the extent to which exchange rate variability is constraining the growth of the tradable sector, it is important to be careful when examining policy options. If variability could be reduced - without other negative consequences - this paper makes the judgement that it is likely the tradable sector would perform better. The lack of certainty about the impact of exchange rate variability on exporters means that the costs of various policies need to be taken into account to ensure that they do not outweigh the benefits.
