What can the Taylor rule tell us about a currency union between New Zealand and Australia?
The merits of a trans-Tasman currency union have been debated in both New Zealand and Australia. It has been suggested that the New Zealand economy may not behave too differently from at least some of the Australian states, ie they have similar characteristics and they face similar shocks. We test this, under the presumption that the differences in Taylor rule implied interest rate paths for different regions over a business cycle can give us some indication about the nature of the differences in "aggregate" shocks that hit different economies. We compare the implied Taylor rule interest rates for the Australian states to the implied Taylor rule rates for New Zealand. We also compare them to the realised 90 day rates. We find that the Taylor rule implied interest rate paths in Australian regions and in New Zealand are not very different.
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