Furthermore, New Zealand based long term rates can be thought loosely of an overnight rates sequence which is influenced by the Bank through the OCR. From this perspective, the OCR also has a benchmark for long term rates of interest in New Zealand. The key corollary is the fact that the shorter the interest rate maturity, the tighter is the connection to OCR prevailing. On the contrary, as the interest rate maturity lengthens, its level is dependent highly over future OCR settings expectations (Kelsey, 2015). OCR adjustment influences other rates of interests but the range of such influence is dependent over whether the transition was anticipated through markets of finance. Whether the Bank has the ability of providing a future policy indication is different from markets prevailing view.
Another set of causal connection in the mechanism of monetary transmission is from newly determined rates of exchange and interest and other prices of asset for the aggregate economic activity aggregate level. Such links are complicated from the fact that there are several second order influences which can either offset or strengthen the direct interest rates influence over activities (Kashyap et al., 2012). An example can be quoted here those changes in interest rates that need a household for making large payments of mortgage over prior levels, for a particular income level generally result in discretionary spending reduction over the services and goods. An enhancement in saving can further be expected considering that the saving return increases with higher rates of interest.
The theory dominant across overseas and in New Zealand to think on the connection between activity of aggregate as well as inflation is a relationship of economy known as the Phillips curve expectations augmentation (Wood, 2016). The important characteristics of this relationship within New Zealand and its significance to the monetary policy transmission process are given below:
When aggregate result expands more than the supply capacity of economy, a positive gap in output hence gets opened up and inflation non-tradable enhances (Krippner, 2013).
An increase in inflation further causes future inflation expectations to enhance.
For presenting inflation of ever increasing nature and expectations of inflation, a response is required that deals with dynamics of monetary policy for returning output to levels potentially and for re-anchoring expectation of inflation at the rate of target.