six to nine months it will stay down at these levels permanently. indeed, if our economy prospers, we should expect to see a gradual appreciation of the exchange rate over the long - term. perhaps farmers need to think about the exchange rate the way canterbury farmers think about rain. sooner or later, droughts are going to happen. consider what we call “ the real exchange rate ”. the real exchange rate is new zealand ’ s nominal exchange rate, adjusted by the difference between inflation in new zealand and inflation in our trading partners. this is more relevant to exporters than simply looking at the nominal exchange rate : clearly, if inflation within new zealand is markedly higher than that in our trading partners, even a falling exchange rate is of little help to exporters, while if our inflation is markedly lower than that in our trading partners, exporters can cope with an appreciating exchange rate. when the real exchange rate rises, or in other words when the nominal exchange rate rises by more than the difference between our inflation rate and that of our trading partners, exporters are put under real pressure. and vice versa. now have a look at graph 1. graph 1 nominal and ’ real ’ trade weighted exchange rate ( 1970 - march 1998 average equals 100 ) index index nominal twi foreign / domestic price level ’ real ’ exchange rate [UNK] the solid line is the nominal trade weighted index, in other words the nominal exchange rate. the dotted line shows the difference between inflation in new zealand and inflation in our trading partners. as you can see, over long periods of time, the nominal exchange rate tends to reflect the difference between our inflation rate and that of our trading partners : when our inflation was relatively high, our exchange rate tended to depreciate ; when our inflation was relatively low, our exchange rate tended to appreciate. of course, there have been divergences between the two lines, sometimes for periods of three or four years at a time, and that is illustrated by the dashed line, or real exchange rate. but over the whole period shown, nearly 30 years, there has been no persistent tendency for the real exchange rate to rise or fall, and that is true despite the fact that through the first half of the period the exchange rate was essentially pegged to the us dollar ( with periodic devaluations ) while for the last 13 years the currency has been floating. the dashed line - the real exchange rate - has fluctuated around a pretty flat trend - line

sectors to reduce debt, as the opportunities for leveraged investment in housing and other assets will be much reduced. this increased propensity to save may blunt the impact one might otherwise expect from fiscal and monetary policy stimulus. finally, external surplus - running emerging markets, especially in asia, will have strategic consumption and investment choices to make. their broad development strategy in the early to mid - 2000s was to grow national income by exporting cheap consumer goods to developed, largely deficit - running, economies. this strategy will now be less viable given household and national financial retrenchment, and pressure on exchange rates to fall to assist in the reduction of imbalances, in the west. asian governments will need to generate large increases in consumption and domestic investment demand, to replace the gap left by exports, if they are to continue growing at the high rates needed to meet their national and social development objectives. the net financial flow from east to west that characterised the middle part of this decade will as a consequence need to fall somewhat, even if it doesn ’ t reverse. as the large emerging markets such as china and india continue to develop amid these large shifts in global economic and financial currents, the reduced dependence of the world on consumption and investment in the west and consequent shift of political power will accelerate. new zealand ’ s position new zealand, like the rest of the asia - pacific, has thus far held up better than many developed economies. the global financial crisis hit the northern hemisphere first, and hardest. the transmission of the shock to us through asia and australia – which together account for half our trade in goods – has been slower than the transmission from the us to europe. however, we haven ’ t escaped unscathed either financially or economically. new zealand investors have lost money. sectors of the new zealand economy exposed to external demand have weakened sharply. a few factors count in new zealand ’ s favour. the parts of the us and european capital markets that have been most damaged are investment banking, hedge funds, private equity, sovereign wealth funds, and stock, bond and derivatives markets. new zealand ’ s direct exposure to these parts of the international capital markets, and to complex derivatives or structured credit products, is very light. our banking system is well - capitalised, vanilla, and mortgage lending is generally on good credit quality. the large australian banking groups, of which the major new zealand banks are a part, are now among the largest and highestcredit - quality banks in the world