4 Drivers of the New Zealand real interest rate premium
The previous section provided evidence of New Zealand's real interest rate premium. Despite higher interest rates, New Zealand as a whole appears to save less than other countries in the OECD. New Zealand's net national saving rate has been consistently and materially below the median of OECD countries.[6] Low rates of national saving relative to domestic investment are reflected in New Zealand's persistent annual current account deficits (refer to Box 1).
Box 1: Saving in the national accounts
The main measure of saving is derived from the national accounts. In the national accounts, saving is a flow measure and is measured as the difference between some measure of income and some measure of expenditure or consumption (both public and private). The usual macroeconomic notation is to define national saving as
S = Ynet – C
where S is net national saving, Ynet is national disposable income (net of consumption of fixed capital) and C is private plus government consumption expenditure. Income also excludes capital gains or losses. Using the familiar national accounts identity,
GDP + NIT – C = I + [X – M] + NIT
NIT is net income and transfers paid abroad, I represents gross investment, X is exports, M is imports and the term [X – M] + NIT is the current account balance (CAB). It can be shown that:
Ygross - C = I + CAB
Deducting consumption of fixed capital from Ygross (gross national income) and I gives:
S – Inet = CAB
New Zealand’s current account balance is in deficit. This identity shows that investment in New Zealand is financed from a combination of national saving and foreign saving.
Statistics New Zealand (2007)
Given that national investment exceeds saving, foreign investment is a necessary and important source of funding to maintain current investment levels (all else equal). However, it is commonly argued that real interest rates are on average higher in New Zealand than in other OECD countries because investors will lend to New Zealand only at those higher rates as compensation for the risk borne when investing in New Zealand. The types of risk being compensated for could include currency risk, default risk, inflation risk and liquidity risk. That is, it is these country risk premia that prevent New Zealand from accessing the lower “world” real interest rate.
This paper argues, however, that for most of the past two decades, this premium on New Zealand real interest rates relative to the “world” rate has been less about externally-imposed country risk premia and more about domestic saving and investment imbalances.
This section presents a basic framework for thinking about these alternative views of the drivers of the interest rate premium. This framework is not intended to be a rigorous model, but it captures some of the stylised facts about the New Zealand economy discussed above, including elevated interest rates and exchange rates.
Notes
- [6]For a detailed analysis of New Zealand saving and a policy discussion, refer to the Treasury's discussion document Saving in New Zealand: Issues and Options (2010).
