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.
(NB. If you do not have the free Acrobat reader software necessary to read these discussion papers already installed, go to the Adobe website.)
Papers for 2004
DP2004/08
Examining finite-sample problems in the application of cointegration tests for long-run bilateral exchange rates
Numerous empirical studies investigate whether exchange rates are related to `economic fundamentals' in the long-run and find a range of relationships through cointegration analysis. We report similar cointegrating relationships for the value of the New Zealand dollar relative to the US dollar (NZD/USD) and for the value of the New Zealand dollar relative to the Australian dollar (NZD/AUD). These include determinants such as commodity prices, 90-day interest rate differentials, and inflation and growth differentials. However, Godbout and van Norden (1997) demonstrate that finite-sample problems may have affected the conclusions of such cointegration studies. Through a simple Monte Carlo study, we consider whether the cointegration coefficients can reasonably be interpreted as `long-run' elasticities of the exchange rate to changes in fundamental variables. The simulation results suggest that given a relatively short span of data it is possible for cointegration analysis to indicate that a long-run relationship has been found when in fact there is only a cyclical relationship. Therefore caution is advised when interpreting the empirical results and making policy assessments about the nature of exchange movements relative to its broad trend.
DP2004/07
A model of Equilibrium Exchange Rates for the New Zealand and Australian dollar
This paper extends the `Five Area Bilateral Equilibrium Exchange Rate' (FABEER) model used in Wren-Lewis (2003) to include New Zealand and Australia. This model calculates medium term exchange rates conditional on assumptions for `sustainable' current accounts. The model suggests that the equilibrium value of both currencies has been declining over the last ten years and that both currencies were near fair value (on average) during 2002. Equilibrium values against the US dollar are estimated to be around 0.50 (New Zealand) and 0.59 (Australia), although these estimates are sensitive to the assumed equilibrium values for variables like commodity prices and the current account.
DP2004/06
Improving implementation of inflation targeting in New Zealand: an investigation of the Reserve Bank's inflation errors
I investigate New Zealand's rate of inflation and its deviations from target using two new methods: 1) Rowe's (2002) new way of examining the correlations between inflation deviations from target and indicators. Any significant correlations, whether in a simple or multivariate framework, are interpreted as evidence against optimal policy setting. 2) Cukierman and Gerlach (2003) and Ruge-Murcia's (2001) new inflation bias hypothesis. As a counterpoint to Kydland and Prescott's (1977) and Barro and Gordon's (1983) time inconsistency explanation of inflation bias, Ruge-Murcia, Cukierman and Gerlach take the different view that even if central banks target the natural rate of unemployment or the potential level of output, some inflation bias might still exist if their loss function is asymmetric. I examine the inflation errors from 1982 to 2003 to investigate how information contained in these might be used to improve future inflation targeting in New Zealand.
DP2004/05
What can the Taylor rule tell us about a currency union between New Zealand and Australia?
The merits of a trans-Tasman currency union have been debated in both New Zealand and Australia. It has been suggested that the New Zealand economy may not behave too differently from at least some of the Australian states, ie they have similar characteristics and they face similar shocks. We test this, under the presumption that the differences in Taylor rule implied interest rate paths for different regions over a business cycle can give us some indication about the nature of the differences in "aggregate" shocks that hit different economies. We compare the implied Taylor rule interest rates for the Australian states to the implied Taylor rule rates for New Zealand. We also compare them to the realised 90 day rates. We find that the Taylor rule implied interest rate paths in Australian regions and in New Zealand are not very different.
DP2004/04
Estimates of the output gap in real time: how well have we been doing?
This paper addresses the real-time versus ex-post properties of the output gap as quantified by the Reserve Bank of New Zealand's multivariate (MV) filter, starting with the second quarter of 1997, when the current procedure was implemented.
There are three sources of revisions of the output gap: revisions of real GDP data, the end point problem of symmetric filters and changes to the calibration of the MV filter.
The performance of the output gap with respect to signalling inflationary pressure, as measured by future non-tradables inflation, has been reasonably good, both in real time and ex post. However, during the recorded history of the MV filter, the revisions to real-time output gap have been no smaller than had a standard Hodrick-Prescott (HP) filter been used. Moreover, the MV filter leads to permanently different levels of the output gap estimates if compared to a purely statistical trend.
The MV filter is a hybrid construct. The empirical reference to indicators of inflationary pressure distances it from the original concept of the output gap, where a deviation of observed from potential output is taken as a cause of inflationary pressure. There is some indication that a major recalibration of the MV filter in 2002 helped to maintain the correlation with a target variable that it is supposed to "explain".
DP2004/03
The equilibrium exchange rate according to PPP and UIP
This paper uses Purchasing Power Parity (PPP) and Uncovered Interest Rate Parity (UIP) to estimate a time-varying equilibrium for the $NZ/$US nominal exchange rate over the period 1992 to 2003. While PPP is supported, the data does not support the strictest form of UIP. The estimated equilibrium can be considered a Behavioural Equilibrium Exchange Rate (BEER) that is conditional on interest rates and price levels. The large swings in New Zealand's exchange rate during the 1990s were broadly consistent with the estimated conditional equilibrium, while the equally large swings in the exchange rate since 2000 were moves away from the conditional equilibrium. This may be because some factor other than interest rates or price levels has driven the exchange rate away from the conditional equilibrium since 2000. Alternatively, the long-run relationship between interest rates and the exchange rate may have changed since the 1990s.
DP2004/02
Do inflation targeting central banks behave asymmetrically? Evidence from Australia and New Zealand
This paper tests the standard quadratic approximation to central bank preferences on data from Australia and New Zealand, two of the earliest explicit inflation targeting countries. The standard linear-quadratic monetary policy model assumes central bank preferences over key macroeconomic variables, such as inflation and output, can be usefully approximated by a quadratic function. This approximation implies that a deviation from a target is considered to be equally costly irrespective of whether the deviation is positive or negative. Combined with a linear model of the economy, quadratic preferences are useful because they yield a first order condition that implies a linear interest rate reaction function. This paper relaxes the assumption of quadratic preferences by allowing central banks to regard the costs associated with positive and negative output gaps differently. Our models also test for the possibility that positive and negative deviations of inflation from target to be treated differently. During the inflation targeting period in both countries, evidence suggests that we cannot reject quadratic preferences over inflation deviations (from target). We cannot reject that New Zealand's preferences regarding deviations of output from trend are quadratic, but Australia's behaviour does not appear to be consistent with quadratic preferences. Instead, the preferences of the Reserve Bank of Australia appear to be more accurately modelled with an asymmetric loss such that the Reserve Bank of Australia views negative output gaps as more costly than positive output gaps.
DP2004/01
Estimating a time varying neutral real interest rate for New Zealand
The interest rate which corresponds to neutral monetary policy settings in New Zealand appears to have trended downwards since at least the stabilisation of inflation in 1992. We present several alternative estimates of a time varying neutral real interest rate (NRR) in state space models, which all show the same declining trend. We then test for a relationship between the Neo-Wicksellian real interest rate gap and future inflation. As in Neiss and Nelson (2003), these two are highly correlated.
Discussion paper correspondence can be directed to:
Economics Department
Reserve Bank of New Zealand
PO Box 2498
Wellington
New Zealand
