Nominal interest rates, inflation and uncertainty in New Zealand

Abstract

This thesis investigates the linkages between nominal interest rates, expectations of inflation and uncertainty in New Zealand. Emphasis is given to three subperiods during which financial markets were subject to little or no regulation. On a quarterly basis these were identified as September 1962 to December 1971, June 1976 to September l98l and June 1985 to December 1991. The availability of interest rate data in New Zealand is carefully examined and the range of data available documented. The lack of suitable time series necessitated hand collection of date from newspapers and these are presented. The availability of data on expectations of inflation is also addressed and a number of time series presented. Regression analysis and cointegration techniques are used. The power of empirical work is limited by the need to focus on quarterly data, due to the availability of data on inflation and expectations of inflation on a quarterly basis, and the relatively short subperiods identified. The issue of data adequacy is a common problem faced by New Zealand economic researchers. The evidence presented supports the hypothesis that interest rate determination was different in the three subperiods identified. In general evidence for the second subperiod is not supportive of a relationship between nominal interest rates and expectations of inflation. Evidence for the first subperiod is slightly more supportive. Data from the third subperiod, commencing in June 1985, were more consistent with the hypothesis that inflation expectations are an important determinant of nominal interest rates but the results of hypothesis testing were ambiguous. The evidence is consistent with the level of inflation expectation uncertainty and interest rate volatility increasing over time. There is also evidence in support of a changing relationship between interest rates and uncertainty over time, with a measure of interest rate volatility identified as a significant determinant of 90 day interest rates in the post 1985 period but not for earlier subperiods.