Last week, during talks with Prime Minister Julia Gillard, Mr Key agreed to resettle 150 asylum seekers held in detention on Nauru and Papua New Guinea's Manus Island.
"For some reason Australia went mental back in the Howard regime and it's never got the same since," he told Radio Australia.
"And it's wrapped itself up in funny arguments, about queue jumpers, which is false, about mass detention of women and children, locking people up, breaching international conventions.
"And now tragically they've sucked New Zealand into the mess."
Ms Gillard announced the deal with Mr Key after leaders' talks in Queenstown, on the South Island.
Ms Gillard says the deal could affect asylum seekers now being held in processing centres on Manus Island and Nauru.
"The aim here is to have it start in 2014 and be ongoing," she said.
"The 150 could be drawn from people who are in Australia now and we would want to work with PNG and Nauru so it is possible that some of the 150 could come from [those] who are processed on PNG and Nauru."
Mr Key says New Zealand will not increase its overall intake of asylum seekers from its present level of 750 a year, but that number will now include those from Australia.
"Australia is grappling with the huge challenge of illegal arrivals by sea and is at the forefront of the efforts to disrupt people smuggling across the region," Mr Key said.
"As part of our support for a regional approach, New Zealand will resettle 150 genuine refugees annually from the Australian system ... as part of the 750 refugees that we annually take.
"So it's not an increase in the number of refugees New Zealand takes but a different sourcing of the location of those refugees."
But the Australian Opposition immigration spokesman Scott Morrison is not convinced.
"What this arrangement has the risk of doing is putting a bit of Kiwi sugar on the table for people smugglers," he said.
"What we should have been talking about is how New Zealand and Australia can be working together, through the Bali process, to beef up natural deterrents."
He says the talks should have focused on things like improved training of immigration and customs officers, better border protection technology and regional border patrols.