N.Z.’s high rate misleading?

Press, 2 June 1989, Page 4

N.Z.’s high rate misleading?

Treasury papers released to “The Press” yesterday confirm that New Zealand has among the highest real (inflation-adjusted) interest rates of its trading partners.

But depending on the way real interest rates are measured, New Zealand’s rates may in fact be lower than those of Australia and Italy.

In common with both those countries, the Treasury’s calculations show that New Zealand had higher average inflation over the last five years, at 12.6 per cent, than the other countries measured.

The study, prepared for a recent Cabinet briefing, is based on studies of inflation and interest rates in Australia, Britain, the United States, Japan, . France, Canada, Germany, Italy, and New Zealand.

Average inflation over the last

five years in all those countries was 5.1 per cent. In Australia it was 7 per cent, and in Italy 7.6 per cent. A poor past inflation record counted heavily against a highly indebted country like New Zealand, the report said.

International investors looked to that and expected a higher interest rate to compensate for the risk of their investment.

“During a recent visit, a group of Japanese investors were reportedly more interested in our annual inflation rate for the past 10 years than for just the last few quarters,” the report said.

Doubts about future deficit reductions rather than the present level of the Budget deficit also appeared to be an important factor overseas investors took into account.

Using the conventional method of calculating real interest rates, the Treasury found that New

Zealand, at 9.1 per cent, was the highest of any country surveyed. This was calculated by taking present interest rates and the inflation rate for the last year. But the report suggested this was the wrong way to view real interest rates.

Since investment decisions were determined by expected real returns in the future, it was more appropriate to measure real interest rates using the expected rate of inflation. On this basis, New Zealand’s real rates slipped to third highest, and closer to the international average. This was because of New Zealand’s comparatively good inflation record of recent times against rising world inflation and interest rates.

Assuming 6 per cent inflation in the year ahead, New Zealand’s real rates were running at 7.1 per cent, the report suggested. This was well below Australian

real rates of 8.9 per cent, and a little below Italy at 7.4 per cent. But even on this basis, New Zealand’s real interest rates were still 1.2 per cent above the 5.9 per cent average of the countries involved.

The paper also claimed high interest rates might not be discouragement to new investment.

“A recent analysis of the United States economy shows that during the past 50 years, periods of high economic growth corresponded to periods when real interest rates were high,” it said.

“Interest rates may not be the primary determinant of investment behaviour. Rather, investor confidence may be more important.”

The paper rejected a link between high levels of Government sector borrowing and high interest rates.