Recent Reserve Bank discussion papers (with abstracts)
Reserve Bank discussion and research papers present the detailed scholarly research of staff economists and visiting scholars. The papers are published throughout the year mainly for academic and professional economists.
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Papers for 2003
Speculative behaviour, debt default and contagion: A stylised framework of the Latin American Crisis 2001-2002
This paper provides a model incorporating strategic speculative behaviour into a framework of debt default and contagion. A basic model of contagion shows how economies which appear fundamentally sound, can fail to meet foreign obligations when there are inter-linkages with a defaulting country. Introducing speculators into the framework increases the incidence of debt default and contagion. However, when these speculators view the economy with a degree of uncertainty, the likelihood of default and contagion is even greater. Speculators' perceptions over the state of the economy are therefore paramount when estimating the impact of a crisis on a region.
DP2003/09
Monetary policy and the volatility of real exchange rates in New Zealand
The relationship between interest rates and exchange rates is puzzling and poorly understood. But under some standard assumptions, interest rates can be adjusted to smooth real exchange rate movements at the possible price of increased volatility in other variables. Estimates made under some generous suppositions about what monetary policy is able to accomplish suggest that decreasing real exchange rate volatility by about 25 per cent would require increasing output volatility by about 10-15 per cent, inflation volatility by about 0-15 per cent and interest rate volatility by about 15-40 per cent.
DP2003/08
The stabilisation problem: the case of New Zealand
This paper examines stabilisation bias - the difference between the inferior macroeconomic outcomes attained with discretionary monetary policy relative to the ideal that could be attained with commitment policy. The paper works within the linear-quadratic framework and represents the monetary policy problem for the central bank as setting the interest rate in order to minimise an explicit loss function for macroeconomic variables. The government's problem is one of "optimal negotiation", whereby the government, representing society, joins with the central bank to search for the optimal set of loss function parameters to be embedded in a contract with the central bank. The framework, due to Rogoff (1985), is usefully applied to the case of New Zealand where recent Policy Target Agreements - contracts between the government and the central bank - are interpreted as representing society's preferences between inflation, output and other dimensions of macroeconomic stability. Within the context of an estimated, small open economy model, a sizeable stabilisation bias is found for New Zealand. Substantial reductions in the stabilisation bias can be achieved by strategic optimal delegation behaviour on the part of the government. It transpires that the weight the central bank should have on the variance of the output gap is considerably lower than the weight society places on the variance of the output gap.
DP2003/07
Has the rate of economic growth changed? Evidence and lessons for public policy
New Zealand's recent rate of economic growth has remained strong despite a worldwide recession. Policymakers, the press, and the public have nonetheless been concerned that New Zealand's economic performance has lagged along some important dimensions. This paper presents some new estimates of the rate of technological change in New Zealand and compares them to similar measures for the United States and elsewhere. New Zealand has not participated in the increased pace of technological progress seen elsewhere since the mid-1990s. Technological change creates sustainable increases in income and wages. Hence, it should be an important focus of policy discussions surrounding economic growth. The paper also addresses how public policy should take into account technological change, especially given uncertainty about future prospects for its growth and the difficulties of public policy in changing its growth.
DP2003/06
Estimates of time-varying term premia for New Zealand and Australia
Forward rates in the money market are systematically higher than realised spot rates, reflecting an unobservable term premium. This paper uses a Kalman filter specification to produce time-varying estimates of the term premia in New Zealand and Australia. Three time series specifications are used to examine the properties of the premia, such as the average size, volatility, and the degree of mean reversion.
DP2003/05
Learning process and rational expectations: an analysis using a small macroeconomic model for New Zealand
The nature of expectations matters when conducting monetary policy. Models with a learning process can exhibit very different properties from models with other types of expectations rules. This paper draws on the work of Orphanides and Williams (2002), extending it to allow for the possibility that the learning process may not be perpetual, but rather might be converging towards a rational expectations equilibrium. By modelling expectations using a learning process, we obtain evidence suggesting that inflation expectations in New Zealand are moving towards rational expectations. Theory suggests this will make it easier to control inflation after a temporary disturbance.
DP2003/04
Monetary policy transmission mechanisms and currency unions: A vector error correction approach to a Trans-Tasman currency union
Transmission mechanisms are the channels through which monetary policy affects macroeconomic variables, such as GDP and inflation. Differences in transmission mechanisms can generate asymmetric behaviour among currency union partners when they experience shocks. This has the potential to widen existing cyclical variation between members of a currency union. We examine the similarity of transmission mechanisms in New Zealand and Australia and consider the implications this has for a currency union between the two economies. We examine these using the Vector Error Correction methodology. While conclusions using this methodology for New Zealand and Australia remain quite fragile, our analysis nevertheless suggests that the transmission mechanisms in New Zealand and Australia do display many similarities. In particular the adjustments of both GDP and the CPI in response to monetary policy shocks appear to be very similar. However there are some differences in terms of the size of the responses of some of the variables to identical monetary policy shocks. In a currency union with a different exchange rate pattern and with different monetary policy shocks, New Zealand may experience some new challenges.
DP2003/03
Modelling structural change: the case of New Zealand
This paper documents the Reserve Bank of New Zealand's current approach to dealing with structural change, an important feature of New Zealand's recent macroeconomic history after the profound economic reforms undergone in the past twenty years. Traditional estimated macroeconomic models of New Zealand have broken down over time, which led to the mid 1990's creation of the Forecasting and Policy System (FPS). In this paper, we analyse why the FPS has proved more robust to structural change and discuss steps we are taking to develop carefully chosen alternative models to complement FPS. Because those alternative models are clearly subject to structural change as well, in developing them we have looked hard at estimation approaches that allow for structural instability. In this paper, we document the results of subjecting some key nominal relationships to stability tests and explicit modelling of structural change. We find preliminary evidence that New Zealand's inflation targeting regime has caused structural shifts in pricing behaviour and expectations formation.
DP2003/02
On applications of state-space modelling in macroeconomics
This paper reviews the literature on applications of state-space modelling to macroeconomic questions, with four examples related to modelling unobserved trends, transition across different steady states, expectations formation and forecasting/data revision issues. Due to the flexibility of the state-space approach, it is both a useful tool for research purposes and highly useful in addressing practical issues. In many cases, state-space modelling offers the possibility of building encompassing models, and formulating rather complicated problems in a simple manner.
DP2003/01
Financial deregulation and household indebtedness
Low saving rates and high indebtedness are characteristics of the household sector in many developed countries. As in other countries, financial deregulation has contributed to increased household indebtedness in New Zealand. This paper discusses several aspects of the linkages between deregulation and household consumption decisions. It begins with an overview of the financial sector reforms and a discussion of how the reforms affected households' access to credit. Secondly, the effect of a change in house prices on consumption is measured. Given that New Zealanders hold about 80 per cent of their wealth in housing, changes in house prices have the potential to materially affect household consumption decisions. Also, there is evidence that the effect of changes in housing wealth on consumption is stronger in the period after deregulation. Thirdly, the role of the household sector in the current account is discussed as banks have increasingly been borrowing overseas to fund household borrowing. The results indicate that the household sector's net overseas surplus declined by at least $7 billion over the last decade. Finally, the ability of the household sector to weather an economic downturn is considered. Highly leveraged households are more vulnerable in times of stress, and their debt servicing capabilities might deteriorate when interest rates rise. Also, deterioration in household balance sheets could negatively impact the financial sector.
Discussion paper correspondence can be directed to:
Economics Department
Reserve Bank of New Zealand
PO Box 2498
Wellington
New Zealand
