alan bollard : handling our economic recovery speech by dr alan bollard, governor of the reserve bank of new zealand, at the local government new zealand, dunedin, 6 may 2010. * 1. * * the global financial crisis caused major market damage we are now seeing the world pull gradually out of the global financial crisis. it was an unexpected, deep and costly event, the world ’ s worst since the great depression. the recovery is mixed, fragile in some places and has a long way to go. just as we were very uncertain about the depths of recession, so no one can be sure how robust and widespread the recovery will be. already we have had many surprises. the purpose of this presentation is to analyse new zealand ’ s recovery from the recession to date, and to indicate how it might proceed. the crisis struck across almost all countries and almost all sectors. like a virulent virus it transmitted speedily from one market to another. some of these markets produced their own antibodies very quickly, while others sustained prolonged damage. the figure gives an impression of when the virus hit and how it quickly passed through the world ’ s financial and economic systems. 2. economic recoveries can be slow and fragile recovery from a global economic recession that has been sparked by a financial crisis is particularly hard to predict. that is because established fundamental economic relationships have been put at risk and may need to be rebuilt over time. research into historical world crises yields some interesting results. international financial crises yield particularly deep and prolonged recessions when they are linked with banking and currency crises. a similar trend can be seen for globally synchronized recessions ( imf, 2009 ). economic contractions tend to last for around six quarters, with an output loss of around 3. 5 per cent. such periods are also associated with employment continuing to decline for substantially longer than gdp ( reinhart and rogoff, 2008 ). on balance after a banking crisis, recoveries tend to be more gradual, and are associated with weak domestic demand, tight credit conditions, and continued contractions in residential and business investment. in addition, recovery is not even across countries and across sectors. typically certain parts of the economy like equities and stocks recover early. others like the labour market can lag significantly. the figure shows the paths of recession and recovery for us gdp during past recessions over the last 40 years. it can be seen that the recovery from this global financial crisis is slow and still fragile, fra

exchange rate being higher than is currently the case. the bank does intervene in the foreign exchange market from time - to - time. but evidence from the past, here and elsewhere, suggests foreign currency intervention is unlikely to have a sustained impact in lowering the exchange rate. 7 this is because daily foreign currency transactions in new zealand dollars swamp any practical intervention capacity, averaging around $ 100 billion per day with more than 80 percent of the transactions taking place offshore. at best the reserve bank can attempt to smooth the peaks and troughs of the exchange rate. of course, reasonable people can differ on what is the appropriate scale of intervention used to smooth some of the volatility. but the old economic saying that there is no free lunch still applies : the greater the scale of intervention, the greater the financial risk carried by the tax payer. more active macro - prudential policy has been undertaken recently to help reduce the buildup in systemic risk in the banking sector resulting from imbalances in the housing sector. the current low interest rates, although appropriate for the current inflationary environment, are contributing to those financial stability risks. in such circumstances one might consider using monetary policy more aggressively to lean against house prices. 8 while this would mean inflation would take longer to rise to the mid - point of the target band it would reduce the risk of a future crash in the housing market. however, using monetary policy to reduce the financial stability risks of a booming housing market would put additional upward pressure on the exchange rate. instead, we have used macro - prudential policy, in particular the loan - to - value ratio limits, to help moderate the risks in the housing market. this addresses the financial stability issue more directly and reduces the need for monetary policy to put pressure on interest rates and the exchange rate. what, other than monetary policy, will remedy the real exchange rate? saying there is little monetary policy can do about the exchange rate, is not the same as saying there is little that can be done. the reserve bank undertakes a great deal of research and analysis on the exchange rate. one example of this research was an exchange rate forum jointly hosted by the reserve bank of new zealand and the treasury earlier in the see http : / / www. rbnz. govt. nz / research _ and _ publications / speeches / 2013 / 5150125. html. chetwin, w and a munro ( 2013 ) “ contemporary exchange rate regimes : floating, fixed and hybrid ” paper presented to