Academic journal article Journal of Money, Credit & Banking

Financial Deregulation and the Dynamics of Money, Prices, and Output in New Zealand and Australia

Academic journal article Journal of Money, Credit & Banking

Financial Deregulation and the Dynamics of Money, Prices, and Output in New Zealand and Australia

Article excerpt

THIS PAPER INVESTIGATES THE INTERACTIONS among money, prices, and output in New Zealand and Australia over the period 1965-1989. A wide range of measures aimed at economic liberalization and restructuring have been undertaken in these two OECD countries during the 1980s, following relatively unsatisfactory performance in terms of inflation and/or real growth through the 1970s. Although the specifics of their economic performance and the timing of the liberalization measures have differed, in both cases financial deregulations, including removal of capital and interest rate controls and floating of the exchange rate, have been prominent aspects of the reform process. Together with competitive funding of government deficits, these reforms were deemed the preconditions for control of domestic monetary aggregates, and hence inflation, by the monetary authorities. The reforms have generated widespread interest, particularly in the case of New Zealand where a dramatic change of regime occurred in 1984, but the preliberalization interactions among money, prices, and output, and the impact of liberalization on these interactions, have been evaluated in relatively few comparative empirical studies.(1)

In this analysis, multivariate autoregressive models with and without a nominal interest rate are used to evaluate the short-term dynamic and long-term equilibrium relationships among money, prices, and output in New Zealand and Australia for the period prior to financial liberalization and for a full sample that includes observations from the postliberalization period. The results provide econometric evidence on the magnitude of the linkages among the nominal and real sectors of these two economies, with their somewhat different histories of inflation, real growth, and monetary policies, on whether stationary equilibrium relationships are apparent in the long-term behavior of the series, and on whether structural changes resulting from the liberalization process have altered these relationships.

An issue that arises in this context is that the financial reforms designed to enhance domestic monetary control also affected credit creation and the demand for monetary assets. As elsewhere, a somewhat ironic consequence has been that post-liberalization monetary policies in New Zealand and Australia have shifted away from monetary targeting to a more discretionary approach, in which the aggregates play a less important signaling role (Grenville 1989, Spencer 1990). The Treasury of New Zealand (1989) and other critics in both countries have taken issue with this shift in monetary policy, and some critics have called for a greater focus on announced aggregate targets (McTaggart and Rogers 1990). Our results partly address this controversy, since existence of stationary long-term relationships among money, prices, and output and stability of the dynamic adjustment paths to these equilibrium relationships would be minimal preconditions for effective use of a monetary targeting strategy.

An important technical aspect of our analysis is that the specifications for the autoregressive models depend on tests for nonstationarity and cointegration of the vector time series. As recent developments in this area have made clear, a model in levels that ignores the nonstationarity of individual series may lead to spurious regression results, while a model in first differences will be misspecified if the series are cointegrated and converge to stationary long-term equilibrium relationships. We choose among the possible dynamic specifications based on the maximum-likelihood procedure developed recently by Johansen (1988). This procedure allows systematic tests for nonstationarity and cointegration without imposing a priori restrictions on the coefficients of the possible long-term relationships, as would be the case, for example, for univariate tests of stationarity of the velocity of money circulation or bivariate tests of cointegration between money and nominal output. …

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