Extract D
Only a few years ago, the Reserve Bank of New Zealand (RBNZ) was praised for its proactive monetary policy. The New Zealand economy recovered strongly from the global slowdown, growing significantly faster than its main trading partners. Confident in this recovery, the RBNZ raised its official cash rate (OCR) to 1.75%, while other advanced economies maintained near-zero rates.
However, critics argued the rate hikes were premature. Unemployment remained sticky at 5.2%, and inflation was tracking below the mid-point of the target range. The RBNZ was concerned about runaway house prices in Auckland and high levels of farm debt, which prompted them to keep interest rates relatively high to maintain financial stability.
By late 2019, household debt remained highly elevated, yet domestic demand began to weaken significantly. In response, the RBNZ slashed the OCR to record lows to stimulate spending. However, the effectiveness of cutting nominal rates is debated because it becomes highly challenging to boost domestic demand when real interest rates approach zero. On the other hand, these record-low interest rates contributed to the New Zealand Dollar falling sharply in value on foreign exchange markets.
Refer to Extract D. Explain the term 'real interest rates' and analyse why low interest rates may lead to a fall in the value of a currency on the foreign exchange market.
310 exam-style questions on AQA A Level Economics 2.6 The international economy (A-level only), covering 2.6.1 Globalisation, 2.6.2 Trade, 2.6.3 The balance of payments, 2.6.4 Exchange rate systems, and 2.6.5 Economic growth and development. Each one has a worked solution and a mark scheme showing where the marks go.