Factor income shares, the banking sector, the exchange rate, and the New Zealand current account deficit

Abstract

The clean float of the New Zealand exchange rate exposes financial institutions to potentially undesired volatility of the nominal exchange rate. In the New Zealand exchange‐rate adjustment process of 1998–2000 the data seem consistent with the idea that, intentionally or unintentionally, the behaviour of the overseas‐owned trading banks amounted to management of the exchange rate (support for the Kiwi) during the adjustment period from 1998 to 2000. Whether this represented the exercise of market power in a coordinated fashion, or was simply a natural decentralised response to market incentives facing the banks, is not clear. The paper suggests that in the absence of large volumes of short‐term credit advanced by overseas parents to their New Zealand bank affiliates, the nominal exchange rate would have been under far greater downward pressure during 1998–99, and the economy might have faced a classic financial and exchange‐rate crisis in the wake of the Asian meltdown.

Notes

Geoff Bertram, School of Economics and Finance, Victoria University of Wellington. Preliminary work on this project began while I was a visiting fellow at the New Zealand Institute of Economic Research in late 2000. Earlier versions of this paper were presented to the Symposium on Sustainable and Excessive Current Account Deficits, Victoria University of Wellington, December 2001, and the Australasian Macroeconomics Workshop, Wellington, April 2002. I am grateful to participants at those sessions, to Dennis Rose and Peter Gardiner for help with data and analysis, and to colleagues at NZIER and Victoria University and two anonymous referees for helpful comments. Remaining errors are my own.