Exchange rate volatility and Reserve Bank intervention : the case of New Zealand

Abstract

In 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 previous 22 years, New Zealand's interest rates had stayed quite high compared to other developed nations. The kiwi dollar started breaking the barriers. RBNZ took the unusual step of intervening in the exchange rate appreciation. Because of this, 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 relationship between the exchange rate and the interest rate. It also helps debate how the central bank controls the volatility in the exchange rate. The teaching objectives are: (1) to understand the desirability and volatility of the two exchange rate regimes; (2) to analyse the relationship between exchange rate and interest rate; (3) to study the reasons for the attractiveness of the kiwi dollar as the desired carry trade currency; and (4) to know how good RBNZ's market intervention was. NOTE: This structured assignment is to accompany the case '207-058-1'. Related: Exchange rate volatility and Reserve Bank intervention: Case Centre Case Reference no. 207-058-1 and Teaching note Case Centre Case Reference no. 207-058-8