The Ministry for Business, Innovation and Employment ignored advice from the Reserve Bank over its new housing affordability measure, and made houses appear to be more affordable than they actually were.
The ministry spent five years developing the housing affordability measure and released it last month, saying it was the end result of a "robust" process.
Its initial report assessed housing affordability between March 2003 to June 2015.
It showed two thirds of renters and 80 percent of potential first-home buyers could not afford their housing costs.
But emails obtained by RNZ show that on 8 May, two days before the ministry publicly released the measure, the Reserve Bank warned it should be using a higher mortgage lending rate in its calculations.
The Reserve Bank said it was discontinuing its effective mortgage rate series, which MBIE was using in the measure, and "this probably wasn't the best measure to be using anyway".
It said the new customer mortgage rate was "more relevant for assessing affordability" whereas the effective mortgage rate was "the average rate on all outstanding mortgages".
Reserve Bank figures show the new customer mortgage rate sits about 1 percent higher than the effective mortgage rate.
In a statement to RNZ, MBIE said it would now change the mortgage rate used in the measure.
"Bottom line - the interest rate measure is being changed, it's an experimental statistic which is in development, and MBIE will be working with the Reserve Bank to develop the new interest rate measure," it said.
The ministry said it had originally chosen to use the effective mortgage rate because it covered a longer time period.
The Reserve Bank declined to make anyone available for an interview, saying it did not want to pick a fight with MBIE in the media.
Labour Party housing spokesperson Phil Twyford said it was extraordinary the ministry went ahead and launched the measure knowing it was based on a "fundamental error".
"If you assume there is a 1 percent difference between the rate they should have used and the rate they actually used ... on a $500,000 mortgage over a 25-year term that would add $3500 in payments to the bank every year.
"That would make it significantly less affordable and I think it shows this measure is ham-fisted actually."
Government ministers have claimed the measure is proof housing is now more affordable than when National came to power - despite house prices surging over the last nine years.