New
Zealand and Australia’s Short Term
Interest Rate Volatility
I plot the daily New Zealand Official Cash Rate (OCR), which
is the Reserve Bank policy rate, and the Overnight Interbak Cash Rate, which is
the interest rate banks charge each others. I also plot the difference between the two
rates (OCR minus the Overnight Interbak Cash Rate). These are averages of daily data by month
from 1999 to 2012.
 |
| Figure 1 |
The two rates are equal until late 2005, when the OCR jumped
significantly such that the difference jumped from zero to 0.42, followed by a
significant decline in both the OCR and the market rate. In 2006, both rates diverged significantly
and the differences never recovered; the divergence is significant and
prolonged.
The Reserve Bank of New
Zealand changed its operating procedure in
2006. The description of this policy change is found in a Bulletin article.[i] Essentially, the Reserve Bank increased
market liquidity significantly. It made
more money available for banks. When the
supply of money increases, the Overnight Interbak Cash Rate should fall, but
that clearly did not happen immediately because the difference in figure 1 is
negative until February 20007, indicating a rise in the market rate above the
cash rate. These differences suggests
that the market was uncertain about the policy change, and perhaps the fact
that the New Zealand
financial market is very thin.
In 2008, the market rate began to equal or be less than OCR,
reflecting the expected response to the policy.
Differences are positive in 2010 indicating the falling of market
interest rate below the OCR and reflecting the policy change in 2006. It took a very long time for market interest
rate to fall. However, the data were
also reflecting the international financial crisis.
Let us look at the same data for Australia. Australia
maintained the same operating procedure throughout. In this case we expect to observe the OCR and
the Overnigh
Interbak Cash Rate to be equal all the time unless there are
some shocks pushing the two rates apart.
Figure 2 shows that differences between the policy rate and the market
rate occurred in early 1999. From 2002
to-date, and during the international financial crisis, Australia’s
OCR and the Overnight Interbak Cash Rate are almost identical, with differences
equal to zero. The Australian market has been adequately liquid.
 |
| Figure 2 |
Figure 3 shows New Zealand’s OCR and Overnight Interbank Cash Rate’s volatility (uncertainty).
 |
| Figure 3 |
New Zealand’s
monetary policy volatility, measured by the monthly average squared changes in
the OCR during the financial crisis, has been low except for a short period in
2009. Monetary policy and market volatility
were equal and only began to diverge in the days and months leading up to the
crisis, during and after the crisis. The market’s volatility has been
significantly higher than monetary policy’s and continues to be so. These persistent differences in volatility
and persistent volatility in the financial market are important research
questions, which might have some real implications.
.
It gets more interesting when comparing the New
Zealand figures to Austraia. Figure 4 shows that New Zealand's volatility is
significantly different in Australia. For Australia, both monetary policy and market volatility
were identical and small throughout the crisis, except for a very small spike
in 2009. During the international
financial crisis Australia’s
OCR had a small blip.
 |
| Figure 4 |
The next two graphs plot the New Zealand and Australia’s OCR and Overnight Interbank Cash Rate together.
 |
| Figure 5 |
Monetary policy volatility during the financial crisis is higher in New
Zealand than Australia’s?
 |
| Figure 6 |
Similarly, financial market volatility in New Zealand, just before, during and after the financial crisis are significantly higher than Australia’s.
The interest rate volatility might have some implications
for the level exchange rate, which will be investigated in the next blog, see
Benigno et al. (2011).[i]
[i] Benigno, G., P. Benigno, and S.
Nistico`, Risk, Monetary Policy and the
Exchange Rate, 2011.
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