Common currency has plenty of allure

By Brian Fallow

Between the lines


Would we have had an easier time in the 1990s if we had had a common currency with Australia?

HSBC Australia's chief economist, John Edwards, thinks so. Monetary union would mean New Zealand ceased to have its own monetary policy and had Australia's instead.

"There seems little doubt," Mr Edwards says, "that monetary integration through the 90s would have meant better outcomes for New Zealand, because it would certainly have meant lower short-term interest rates at critical times, and smoothed the mid-decade currency appreciation."

Certainly, if New Zealand ceased to have a home-grown monetary policy, it would cease to have home-grown monetary policy mistakes.

Don Brash has made a couple of big policy mistakes: Not tightening soon enough at this stage of the last cycle so that he subsequently had to stand on the brakes; and the unfortunate experiment of the monetary conditions index which meant that the post-Asia crisis easing took too long to be felt in lower interest rates.

But there is a case against monetary union too: the larger the area covered by a single currency, the more likely that monetary policy will be ill-fitting for part of it.

Two things can offset that: the movement of labour from struggling to buoyant areas, which occurs already in Australasia; and a heavy flow of tax dollars in the opposite direction which is not even remotely on the cards given that government bail-outs are a policy of the past.

But even within New Zealand there have been times, and not that long ago, when a monetary policy appropriate for Auckland was painful for rural New Zealand.

"It may be that there are more commonalities between most of Australia and most of New Zealand than there are between various parts of New Zealand," Mr Edwards says.

There have been major changes in recent years, which give the Reserve Bank more leeway. The inflation target band has been widened and inflation expectations have been in a trend decline, although there has been a bit of an upturn recently.

Crucially there has been a shift in the bank's thinking about the dollar. It is less concerned about the debatable proposition that a weak currency pushes up the price of imports.

It is more concerned with the exchange rate's effects on aggregate demand 18 months ahead. And the MCI has been replaced by the official cash rate.

These factors add up to a change at least as significant as is likely to flow from the new Government's planned review of monetary policy. It might be a good idea to see if the change will deliver a less volatile and exporter-friendly monetary cycle.

If it does not, as Mr Edwards suggests, support for monetary union with Australia may well increase.