In the process setting what´s maybe a world record for continuous growth: 21 years!
Given they have the same ‘D.N.A.’, why didn´t New Zealand manage the feat? By same ‘D.N.A.’ I mean they´re located in the same geographical region, have the same cultural heritage, both are quintessential commodity exporters and are old-timer inflation targeters. Australia has lots of deserts while New Zealand has lots of mountains, but that´s irrelevant. Australia is much bigger, but that´s also irrelevant because monetary policy is easily scalable.
And I´ll argue that it was each country´s practice of monetary policy that has made the difference.
In the case of Australia and New Zealand, given they have the same ‘D.N.A.’, we can ‘grade’ the monetary policy of each based on the outcomes, i.e. on things like real output growth, inflation and unemployment in each country following the occurrence of a shock.
The comparative analysis that I undertake is done for two distinct periods: 1997 – 99 which contains the Asian Crisis of 1997 – 98, and 2006 – 11 which encompasses the commodity boost-bust-boom within the world financial crisis of 2008 – 09.
Chart 1 gives a broad characterization of both countries, showing the long run close relationship of their exchange rates against the US dollar and an index of commodity prices. If the lines were not labeled it would be hard to know which is which. The three variables move in sync.
Although hard to distinguish, the interpretation of this process by the Reserve Banks of each country was very different in the late 1990s. While the Reserve Bank of New Zealand adhered to a strict Monetary Conditions Indicator (MCI) according to which a depreciation of the NZ$ had an expansionary/inflationary impact (i.e. tantamount to policy ‘easing’), the Reserve Bank of Australia was much more pragmatic, trying to interpret the nature of the shock, in this case a negative shock to the terms of trade (the ratio of the country’s export and import prices) from the Asia crisis which, in practice, tends to be contractionary/deflationary.
Charts 2 – 5 show the behavior of exchange rates and commodity prices, the monetary policy action described by the policy interest rate and what happened to real output growth and core inflation in both countries in the aftermath of the ‘Asia shock’. The two bars in the charts indicate the moment in which Thailand went “belly-up”, marking the start of the crisis in mid-1997 and the moment Korea went to the IMF in November 1997.
It seems clear that Australia wins the contest ‘hands down’. But why? Chart 3 shows that New Zealand´s Reserve Bank was ‘tricked’ into raising the policy rate by the depreciation of the New Zealand dollar. Australia´s Reserve Bank did not fall into that ‘trap’. When in mid-1998 New Zealand´s Reserve Bank realized its mistake, the policy rate came down on a ‘chute’. But it was too late, the economy had been destabilized.
Chart 6 gives a good summary of the story. While Australia´s Reserve Bank managed to keep nominal spending growing at a relatively stable rate, New Zealand´s Reserve Bank engineered a reduction in nominal spending, which later had to be reversed.
Ten years later, with the accumulated experience and having, among other changes downgraded the ‘bossy’ MCI, New Zealand had become more flexible in its policy decisions but not smart enough to beat Australia at the game.
Chart 7 shows the exchange rate-commodity price relationship from 2006 on. Up to mid-2008 the commodity price boom is closely associated with the appreciation of both exchange rates relative to the US dollar, as expected.
Charts 8 & 9 indicate that the commodity price boom was responsible for the rise above trend in nominal spending in both countries, more so in Australia. It also indicates that in 1997-98, during the Asia crisis, as we saw above, nominal spending was more stable in Australia than in New Zealand. But, even though policy rates were being raised (Chart 10) monetary policy is deemed to have been ‘easy’ during this time.
Chart 11 shows that generally, inflation has not been an ‘issue’ in either country. In Australia the target inflation is 2% – 3%, while in New Zealand it is in the range of 1% – 3%.Interestingly, Australia had an inflation spike during the 2006-08 commodity price boom while New Zealand saw a spike in the 2010-11 boom. The policy rate setting of the two countries at those times may be relevant here.
The big difference in outcomes between the two countries shows up in mid-2008 when nominal spending in the US crashed. As a result commodity prices tanked and Australia´s and New Zealand´s foreign exchange rate depreciated in tandem. Chart 12 shows that while New Zealand´s real output growth took a big hit, turning negative, Australia only experienced a real growth slowdown.
Chart 13 compares nominal spending in both countries. You could be surprised by the fall in spending in Australia. But look back at Chart 10 and you´ll conclude that it mostly reflects the fall in inflation, with real output being only ‘marginally’ affected.
Good monetary policy in Australia shows up in the period leading to the world financial crisis, when the Reserve Bank of Australia did not go ‘all out’ (or as intensively as New Zealand) to restrain the rise in nominal spending from the commodity boom, so when the crisis came it was well positioned to ‘calibrate’ the drop in nominal spending so as to keep it close to trend.
Unemployment in Australia went from 4% in early 2008 to 5.9% in mid-2009. In May 2012 it stood at 5%, the same rate as at the beginning of 2006 when the commodity boom was blossoming. In New Zealand the unemployment numbers are 4%, 6.9% and 6.7% for the same period.
Bottom line: ‘Grading on a curve’, the RBA gets an A. Gather your friends, go to the nearest bar and celebrate!.