Thirdly, the exchange rate tends to be high when relative prospective returns available in New Zealand are above those offshore. Finally, short term interest rates, reflecting the price stability objective of monetary policy, tend to rise in response to increases in future inflation pressure. All of these key macroeconomic variables are therefore linked together by economic behavioural tendencies.
We say “tendencies” because other things than those mentioned matter too, and may at times be substantial drivers of the patterns we see in the data. For example, a major source of exchange rate fluctuations in New Zealand is the outlook for the world prices of our commodity exports and the terms of trade.