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Why are Real Interest Rates in New Zealand so High? Evidence and Drivers

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Abstract

New Zealand real interest rates have on average over the past two decades been high relative to most other countries in the Organisation for Economic Co-operation and Development (OECD). This paper argues that New Zealand’s relatively high interest rates are currently the outcome of domestic saving and investment imbalances, and are less due to a risk premium being imposed by foreign investors. That is, New Zealand’s low rate of saving relative to investment make higher real interest rates necessary to maintain inflation within the target range in the face of higher domestic spending. Foreign inflows seek out the interest rate premium, rather than demand it as compensation for risk. Seeking out the higher yield, foreign capital flows into New Zealand and this puts upward pressure on the exchange rate. It is this relationship between the real exchange rate, exchange rate expectations and the real interest rate that has helped to cause New Zealand’s interest rate to deviate from the “world” rate for most of the past two decades.

Suggested Citation

  • Natalie Labuschagne & Polly Vowles, 2010. "Why are Real Interest Rates in New Zealand so High? Evidence and Drivers," Treasury Working Paper Series 10/09, New Zealand Treasury.
  • Handle: RePEc:nzt:nztwps:10/09
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    File URL: http://www.treasury.govt.nz/publications/research-policy/wp/2010/10-09/twp10-09.pdf
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    References listed on IDEAS

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    1. Michal Brzoza-Brzezina & Jesus Crespo Cuaresma, 2007. "Mr. Wicksell and the global economy: What drives real interest rates?," Working Papers 2007-06, Faculty of Economics and Statistics, University of Innsbruck.
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    Keywords

    Real interest rates; neutral interest rate; real exchange rates; Uncovered Interest Parity; internal balance; external balance; saving;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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