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Examining the Elasticity of New Zealand’s Current Account to the Real Exchange Rate

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Abstract

The main purpose of this paper is to supplement the existing literature by quantifying the elasticity of New Zealand’s current account to changes in the real exchange rate. The unusual composition of New Zealand’s current account balance – particularly the large income deficit and the importance of the agricultural sector to the goods balance – suggests that this relationship for New Zealand may differ from that for other developed countries. As a result, we focus on modelling the relationship between New Zealand’s exchange rate and the current account stripped of four main components: the net investment income balance, dairy exports, the value of both oil exports and imports, and education services exports: what we call the ‘adjusted’ balance. We find that the responsiveness of New Zealand’s current account to the real exchange rate is towards the lower end of most estimates used in other studies. Given that the trade elasticity is a key variable in macro-balance models of exchange rate valuation, we conclude that some previous studies may have underestimated the magnitude of the real exchange rate adjustment needed to help achieve external equilibrium in the long run.

Suggested Citation

  • Kam Szeto & David Oxley, 2014. "Examining the Elasticity of New Zealand’s Current Account to the Real Exchange Rate," Treasury Working Paper Series 14/12, New Zealand Treasury.
    • Handle: RePEc:nzt:nztwps:14/12
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    File URL: https://treasury.govt.nz/sites/default/files/2014-09/wp-14-12.pdf
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    References listed on IDEAS

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    1. Campa, Jose M. & Goldberg, Linda S., 2002. "Exchange rate pass-through into import prices: A macro or micro phenomenon?," IESE Research Papers D/475, IESE Business School.
    2. William R. Cline, 2013. "Estimates of Fundamental Equilibrium Exchange Rates, May 2013," Policy Briefs PB13-15, Peterson Institute for International Economics.
    3. Gemma Mabin, 2011. "New Zealand's Exchange Rate Cycles: Impacts and Policy," Treasury Working Paper Series 11/01, New Zealand Treasury.
    4. Marilyne Huchet-Bourdon & Jane Korinek, 2012. "Trade Effects of Exchange Rates and their Volatility: Chile and New Zealand," OECD Trade Policy Papers 136, OECD Publishing.
    5. Anne-Marie Brook & David Hargreaves, 2000. "A macroeconomic balance measure of New Zealand's equilibrium exchange rate," Reserve Bank of New Zealand Discussion Paper Series DP2000/09, Reserve Bank of New Zealand.
    6. William R. Cline, 2008. "Estimating Consistent Fundamental Equilibrium Exchange Rates," Working Paper Series WP08-6, Peterson Institute for International Economics.
    7. Simon Wren-Lewis, 2004. "A model of Equilibrium Exchange Rates for the New Zealand and Australian dollar," Reserve Bank of New Zealand Discussion Paper Series DP 2004/07, Reserve Bank of New Zealand.
    8. William R. Cline, 2013. "Estimates of Fundamental Equilibrium Exchange Rates, November 2013," Policy Briefs PB13-29, Peterson Institute for International Economics.
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    Cited by:

    1. Kamber, Gunes & McDonald, Chris & Sander, Nick & Theodoridis, Konstantinos, 2016. "Modelling the business cycle of a small open economy: The Reserve Bank of New Zealand's DSGE model," Economic Modelling, Elsevier, vol. 59(C), pages 546-569.

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    More about this item

    Keywords

    Current account elasticity; exchange rate;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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