Monetary Policy Case Study

Exchange Rate Volatility and Reserve Bank Intervention: The Case of New Zealand

OR

Abstract:
n 1985, New Zealand's currency was allowed to float, after the pegging regime. It was during June 2007 that, for the first time, the Reserve Bank of New Zealand (RBNZ) had to intervene in the currency market - to curb the rise in the kiwi dollar. During the past 22 years, New Zealand's interest rates stayed quite high than other developed nations. This was attractive enough for currency traders, especially from Japan, to indulge in carry trade. This party went along only for some time. The kiwi dollar started breaking the barriers. RBNZ took an unusual step of intervening in the exchange rate appreciation. Because of which questions arise like should RBNZ intervene at all? If it should, is its timing correct? What are the permissible levels of kiwi dollar appreciation? What is the better form of intervention? How long should this intervention be continued?

This case study helps in discussing the causes and effects of exchange rate volatility, and also the relation between exchange rate and interest rate. It also helps debate how the central bank controls the volatility in exchange rate.

Pedagogical Objectives:

• To understand the desirability and volatility of the two exchange rate regimes
• To analyse the relationship between exchange rate and interest rate
• To study the reasons for the attractiveness of the kiwi dollar as the desired carry trade currency
• To know how good was RBNZ's market intervention.

Keywords : Exchange Rates, Interest Rates, Fixed and floating exchange rates, Nominal and real exchange rates, Real Interest Rates, Finance Case Study, Exchange Rate Volatility, Carry Trade, New Zealand Economy, Inflation Targeting, Monetary Policy