Prime Minister John Key says Labour leader Andrew Little's suggestion banks be forced to follow changes in the OCR rate would set an "unhealthy precedent" which could do more harm than good to home owners.
Mr Little said he has not ruled out changing the law to force banks to pass on cuts in the OCR to lenders if Labour was in Government.
Mr Key said that showed a lack of understanding of banking. "What he's basically saying is when the Reverse Bank puts the base rate up, he would be forcing home owners to pay a higher interest rate."
He said at the moment the banks did not always put lending rates up when the OCR lifted, especially if there was a "mortgage war" underway with banks trying to undercut each other. He said lending rates were driven by more factors than the OCR, especially international costs of borrowing.
Finance Minister Bill English said Mr Little's proposal was a bad idea.
"We've tried politicians setting interest rates before back in the 1970s and 80s and it doesn't work."
He said it was a "bit of a surprise" from the Labour Party, which had been fairly "mainstream" in its economic policy but was now opposing a major free trade agreement in the Trans-Pacific Partner and proposing setting interest rates.
He did not believe regulation was required to force the banks' hands, saying the market was competitive and some banks were passing the interest cuts on while others would come under pressure to do so.