External imbalances and macroeconomic policy

Abstract

This paper argues that large external imbalances pose significant macroeconomic risks. While New Zealand has coped well in recent years, the global financial crisis has underlined the vulnerability of large-deficit countries to financial shocks. We analyse how the macroeconomic policy framework can be adapted to modify the risks embedded in the international balance sheet.

Keywords:

• external imbalances
• macroeconomic policy
• New Zealand

Acknowledgements

This is a revised version of a paper prepared for the policy forum ‘New Zealand's Macroeconomic Imbalances: Causes and Remedies, 23–24 June 2011, Wellington, New Zealand. I thank Peter McQuade for helpful research assistance, Norman Gemmell for his discussion, and feedback from the editors, the anonymous referees and the conference participants. I am also grateful to staff members at the New Zealand Treasury, the Reserve Bank of New Zealand and many independent economists for helpful conversations and suggestions.

Notes

1. Table 1 compares New Zealand and Australia to regional averages. Country-by-country details are available from the author.

2. The euro periphery holds very little by way of official reserves. As members of a currency union, these countries have access to the liquidity facilities of the European Central Bank and the bulk of their foreign debt liabilities are in euro. Accordingly, there is little need to hold liquid foreign-currency reserves.

3. See also Labuschagne & Vowles (2010) and Rose (2010) on the determinants of the real interest rate in New Zealand.

4. Lane (2010a) provides a more detailed discussion of these issues and reviews the empirical evidence on the effectiveness of fiscal policy in influencing the path of key external adjustment variables such as the real exchange rate.

5. A rainy-day fund is quite distinct from a pension reserve fund (such as New Zealand’s superannuation fund), given that liquidity should not be a major portfolio criterion for the latter in view of its long-term focus.