The currency “war” myth that won’t die

By Matt Nolan 23/01/2013

Over on Rate’s Blog I’ve seen an approving link to an article discussing the “currency wars” that are going on around the world.

As Lars Christensen says here, and as we’ve said on many occassions ourselves given that monetary policy is pegged to an implicit inflation target this isn’t “beggar thy neighbour” policy at all – this is just standard monetary easing.

Now in New Zealand the big complaint is about the exchange rate – many people feel that the New Zealand dollar is “too high”.  However, there are two issues here:

  1. Monetary policy – has NZ monetary policy just been too tight?
  2. Structural policy – are there structural reasons why our exchange rate has been (potentially) persistently over-valued.

We have discussed this before here.

This isn’t a currency war, let me requote something we’ve said before:

Central banks are not breaking the rules, this isn’t a prisoner’s dilemma – competitive devaluations HELP when demand is suppressed … just look at the Great Depression, and the choice of countries to go off the gold standard!

Yes, there likely are structural issues in the New Zealand economy.  But policy makers should be focused on those specifically (why is there insufficient residential building activity, why is the real exchange rate so high) – they cannot be solved by monetary policy or the Reserve Bank.   Even when we think a policy issue is clear we need to be careful, as Noah Smith points out:

It’s important to belabor this last point. Economists know some things, maybe a lot of things, but this is absolutely dwarfed by the size of the things we don’t know and don’t understand. If this blog has had one “unifying theme,” it would be the depth of our ignorance. So when economists urge caution in using policy to change large sectors of the economy, this doesn’t necessarily mean “We know that the free market is always perfect and good and that policy can’t help.”

Instead, caution about policy is very similar to doctors’ maxim of “first, do no harm.” As a doctor, you wouldn’t say “I can’t figure out how this organ is helping the body function, so let’s just take it out.”