Westpac economists have released research showing New Zealand's floating exchange rate has helped reduce price volatility of its commodity exports, rather than add to price volatility. They argue that a policy designed to stabilise the exchange rate would do more harm than good to most of New Zealand's commodity exports. (Update 1 includes link to full piece.) Westpac Chief Economist Brendan O'Donovan and research economist Dominick Stephens said the New Zealand dollar tends to move in the same direction as NZ commodity prices, which insulates most, but not all, commodity producers from global market price volatility. Commodities currently make up 56% of NZ's merchandise exports, they said. Their research looked at price data over 17 years and found that dairy products have benefited most from exchange rate variation. "When world commodity prices fall the exchange rate often falls, limiting commodity exporters' pain. Likewise, when commodity prices rise the exchange rate often rises, limiting commodity exporters' gain," O'Donovan and Stephens said.
"By offsetting global market swings, the exchange rate has reduced the overall volatility of commodity producers' revenue per unit by 25% since 1992. For the dairy industry, the exchange rate has reduced volatility by 27%. Far from buffeting most commodity exporters, the exchange rate has actually buffered them," they said. "Our results imply that a policy designed to stabilise the exchange rate would actually harm the dairy, lamb, horticulture, and aluminium industries (38% of exports). Such a policy would reduce the exchange rate's beneficial buffering effect, exposing exporters in these industries to the vagaries of world markets." However, O'Donovan and Stephens said there were exceptions to this. "For a significant minority of commodity producers, the exchange rate has indeed been a source of volatility. Exchange rate variation has increased the overall volatility of revenues for beef, wool, seafood and forestry exporters." "A policy of exchange rate stabilisation would...be helpful for the beef, wool, seafood and forestry industries (15% of exports), as it would stabilise overall revenues in those industries." O'Donovan and Stephens found that adoption of the Australian dollar would have been even worse than fixing to the US dollar for commodity prices. "As a group, commodity exporters' revenues per unit have been 34% more stable than they would have been if New Zealand had adopted the Australian dollar in 1992. However, wool, seafood, forestry, and aluminium exporters would have been better off under the Australian dollar." They also found that the exchange rate had reduced volatility in the local price of oil by 20%.
It is fairly simple to assess whether the exchange rate has buffered commodity exporters by reducing volatility, or buffeted them by creating extra volatility. We looked at the actual inflation-adjusted New Zealand dollar price that commodity producers have received since 1992. We compared that to the US dollar price commodity producers would have experienced if New Zealand had adopted (or fixed its exchange rate to) the US dollar, adjusted for US inflation.1 We then assess which scenario would have involved greater volatility in the local price paid to commodity producers. "Volatility" is defined as the standard deviation of prices. So the more time commodity prices spend away from average, or the further they swing away from average, the higher the volatility. We chose not to measure volatility on the basis of how "bouncy" prices are from month to month. That's because a price that bounces a few percent either side of average every month is less damaging than a price that experiences large smooth cycles over periods of years. For commodity exporters as a group the results were clear. The standard deviation of real New Zealand dollar prices was 25% lower than the standard deviation of real US dollar prices. Casual observation of the figure below suggests that the effectiveness of the exchange rate as a buffer varies over time. In particular, the exchange rate has been a more effective buffer since 2007 than it was before. Breaking the analysis down by product gave a mixed picture, as table 1 shows. Dairy products have benefited most from exchange rate variation. That is not surprising, considering that dairy is the country's biggest export industry by far, and therefore has the greatest influence on the exchange rate. For example, the dairy boom/bust of 2007 and 2008 saw the NZD appreciate then depreciate almost exactly in tandem with world milk prices, making NZ dollar milk prices substantially less volatile than global prices. Other commodity products that benefit from exchange rate variability are lamb, horticulture and aluminium. The exchange rate is a buffeting force for the beef, wool, seafood, and forestry industries. These industries would have experienced less price volatility if the New Zealand dollar had been fixed against the US dollar. For these products, complaints about additional volatility introduced by the currency are valid.