grant spencer : recent intervention by the reserve bank of new zealand in the foreign exchange market opinion article by mr grant spencer, deputy governor of the reserve bank of new zealand, 27 june 2007. * * * on 11 june, the reserve bank confirmed that it had intervened in the foreign exchange market to sell new zealand dollars. this was the first such intervention since the exchange rate was floated in march 1985. the bank ’ s 11 june announcement has prompted a lot of discussion and commentary around the objectives and impact of fx intervention. it is useful to clarify a number of issues around this subject. foreign exchange intervention is an ongoing process and the bank will not be commenting publicly on its specific intervention activities. we will, however, continue to release our financial accounts, which show the accumulated impact of the bank ’ s intervention activities. these accounts are posted on the bank ’ s website at the end of each month, with a lag of one month. under the bank ’ s policy targets agreement with the minister of finance, the bank seeks to avoid unnecessary variability in interest rates, output and the exchange rate as it goes about maintaining low inflation. the bank ’ s primary monetary policy instrument is the official cash rate ( ocr ). the foreign exchange intervention framework provides an additional tool for the purpose of trying to moderate the extremes of the exchange rate cycle. intervention operates at the margin, affecting the balance of demand and supply for the new zealand dollar. it can have an immediate downward impact on the exchange rate as it did on 11 june. that can help to moderate the “ peaks ” in the exchange and the length of time we spend at peak levels. it does not attempt to defend a particular level of the exchange rate. rather it sends a signal that, in the bank ’ s view, the exchange rate is out of alignment with the economic fundamentals. those speculating in the new zealand dollar need to be aware that the exchange rate is not a one - way bet ; they need to be cautious. the bank ’ s policy is to intervene only when the exchange rate is at exceptional levels ; when it is unjustified by medium term economic fundamentals ; when intervention is seen as consistent with the policy targets agreement ; and when market conditions make intervention opportune. in recent times, the new zealand dollar has been at levels that the bank regards as both exceptionally high and unjustified by the economic fundamentals. many businesses would agree. the high level of the exchange rate is creating challenging conditions for large

safety valve of devaluation was no longer available. but, one needs to recall that it by 1994 trade with the uk was well below that predicted by a simple gravity model ( such as that of brulhart and kelly, 1999 ). but thom and walsh ( 2002 ) argue persuasively that the decline in irish - uk trade was driven by factors other than the ending of the sterling link. though there was one discrete realignment ( involving an appreciation of the 15 % band for the irish pound against the dm ) in march 1998 as the start of the euro approached. bis central bankers ’ speeches was the systematic tendency to over - use that lever that had resulted in the inflationary stop - go of the 1970s and 1980s which was the major backdrop to the determination of many countries to “ import the credibility of the bundesbank ” by signing up for the euro. the absence of a devaluation lever must be considered as a feature, not a bug, in the system. the fault, i am thus arguing, lies not so much in the system ’ s design as in the inadequacy of national economic and financial policies to take account of the risks that were still associated with the euro. there is another dimension worth mentioning. and that is the complacency of financial markets, which assumed that policies would in the end prove adequate ( or, if not, that failing policies would be compensated by bail - outs ) and accordingly did not provide to national authorities until it was too late the uncomfortable warning signals for which bond markets are notorious. indeed, as had been foreseen, for the entire decade before the crisis broke, the single currency removed the risk premium in wholesale irish interest rates, an achievement which was hailed at the time. with the irish economy booming already from 1994 and continuing to grow rapidly after the start of the euro, low interest rates were not exactly what was needed to restrain what was obviously a somewhat overheated economy. but fiscal policy could have taken the strain – as could macroprudential policies. the creation of a sovereign wealth fund ( the national pension reserve fund ) can be thought of as a step in this direction, though the annual 1 per cent of gdp contribution to it did not take enough spending power out of the economy. personal savings were also incentivised by a remarkably generous special savings scheme introduced in 2001, but this scheme disgorged the savings five years later, with the economy still in its boom