Factor income shares, the banking sector, the exchange rate, and the New Zealand current account deficit

Abstract

The clean float of the New Zealand exchange rate exposes financial institutions to potentially undesired volatility of the nominal exchange rate. In the New Zealand exchange‐rate adjustment process of 1998–2000 the data seem consistent with the idea that, intentionally or unintentionally, the behaviour of the overseas‐owned trading banks amounted to management of the exchange rate (support for the Kiwi) during the adjustment period from 1998 to 2000. Whether this represented the exercise of market power in a coordinated fashion, or was simply a natural decentralised response to market incentives facing the banks, is not clear. The paper suggests that in the absence of large volumes of short‐term credit advanced by overseas parents to their New Zealand bank affiliates, the nominal exchange rate would have been under far greater downward pressure during 1998–99, and the economy might have faced a classic financial and exchange‐rate crisis in the wake of the Asian meltdown.