Re: Incomes and Exchange rates; part 3

[Leigh Harkness <leigh@xxxxxxxxxxx>]

Basil

Oz inflation rates are low at around 2%.

And the government no longer sees a high exchange rate as a good thing.  We
have been battling that perception for a number of years and it now appears
the message has got through.

Regards

Leigh



At 11:07 AM 16/9/97 -0400, you wrote:
>Leigh
>Thanks for the Oz data. Interest rate parity theory states that expected
>REAL rates should be equalized. The period  from 83 to 91, when Oz rates
>were very high, was presumably accompanied by high Oz inflation?? Since 91
>the RBA has followed a cheap money policy. The rate differential has even
>become negative in 97?? Does that imply the OZ inflation rate is now below
>the US rate, ie. 3 percent??
>
>Or is the RBA attempting to depreciate the exchange rate??   Basil
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>At 11:28 PM 9/16/97 +1000, you wrote:
>>Basil
>>
>>Thanks for your comments. You wrote that:
>>
>>> My obsevations were based in my stay in
>>>South Africa, where the Reserve bank Is desperately attempting to raise
>>>fereign exchange reserve cover; at present reserves are only about two
>>>months imports.
>>
>>I saw similar pressure to raise foreign reserves on the Philippines from the
>>IMF.  In August last year, they significantly raised foreign reserves. They
>>appeared to have had a half hearted attempt at a fixing the exchange rate.
>>Yet they kept interest rates high.  This initially appears to have attracted
>>a great deal of foreign S/T capital.  However, when the Thai baht suffered
>>serious devaluation, the Philippine currency had a massive outflow of
>>capital that caused the CB to significantly devalue the currency and resume
>>the float.
>>
>>>They are on a flexible exchange rate regime, and are keeping
>>>Bank rate at 18 percent, in the attempt to attract foreign short term
>>>capital , and also (mistakenly), to reduce the inflation rate. This in >the
>>face of 35-40 percent unemployment.
>>
>>I agree it is a mistake.  The foreign capital enters only while interest
>>rates are high.  While using those rates to gather foreign reserves does
>>stimulate the economy with new money, the high exchange rate actually causes
>>the country to import more and export less.
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>>Also, a high interest rate can kill investmen in long term projects.  The CB
>>must maintain them to maintain the value of the currency.
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>>It would do better to forget about the floating exchange rate system,
>>devalue the currency to increase exports and shift spending from imports to
>>domestic products.  This would increase the multiplier and stimulate
>>economic growth, thereby increasing employment.
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>>>So the size of foreign exchange reserves are absolutely critical to SA
>>>monetary policy. That is primarily why I disagreed with your (conventional)
>>>story that a flexible exchange rate regime permits the CB to act more
>>>independently.
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>>I doubt if raising foreign reserves is critical to SA monetary policy.  The
>>SA government may be just doing what the IMF is telling it to do.  I have
>>found the IMF grossly incompetent.  It is neglecting its charter.  It more
>>concerned about trying to force countries to implement neo-classical
>>economic policies.  Keynes would turn in his grave if he could see what it
>>was doing to economies around the world.
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>>>You say that In Oz the CB has tight control of the domestic short term
>>>nominal interest rate. I doubt that very much.
>>
>>>Try to run a regression using  the nominal level of the domestic rate as
>>>the dependent variable. Although I have not looked at OZ data, I feel
>>>confident that the level of foreign rates
>>>will be overwhelmingly the single most important variable. In an open
>>>economy with capital mobility, the CB's reaction function refers to the
>>>differential of the domestic rate over the foreign rate. (In SA the
>>>domestic inflation rate is not even significant in the reserve bank's
>>>reaction function on the nominal ST interest rate.
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>>Movements in domestic money market interest rates are closely linked to the
>>CB's rate.  I cannot find the RBA's prime rates at the moment.
>>
>>However, if US and Oz rates were tightly linked, you would expect them to be
>>similar but they have been varying.  The following compares the US Prime
>>commercial paper rate (6 mth) with the Oz 180 day bank bill rate (June rates
>>except for 1997 which is the May rate).
>>
>>	US	Oz	% Diff
>>1983	9.03	13.57	50%
>>1984	11.23	12.73	13%
>>1985	7.38	16.46	123%
>>1986	6.63	14.78	123%
>>1987	7	13.36	91%
>>1988	7.53	13.13	74%
>>1989	8.8	18.28	108%
>>1990	8.06	15.06	87%
>>1991	6.16	10.48	70%
>>1992	3.99	6.41	61%
>>1993	3.38	5.25	55%
>>1994	4.86	5.47	13%
>>1995	5.79	7.57	31%
>>1996	5.57	7.59	36%
>>1997	5.78	5.63	-3%
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>>As you can see, one rate is not a good predictor of the other.
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>>While interest rates are important to the finance market, I do not see
>>interest rates as being as important in the real economy as exchange rates
>>and changes in the money supply (and what changes it).
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>>Regards
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>>Leigh
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>>______________________________________________________________________
>>Leigh Harkness                                      leigh@xxxxxxxxxxx
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>Basil Moore, Department of Economics
>Wesleyan University
>685-2363
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______________________________________________________________________
Leigh Harkness                                      leigh@xxxxxxxxxxx