Interest Rates, the Reserve Bank and the Government
As a backdrop to this article, you could revisit my Blog of December 2023 Inflation, Interest Rates, and You.
The Reserve Bank [RBA] was created in 1960 with a mandate to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people. Although it is wholly-owned by the commonwealth government and the Governor of the Reserve Bank is appointed by the Treasurer, it remains a completely independent body. The RBAs independence ensures that its decisions are based on economic factors, not political ones.
There is currently a lot of media attention being focused on the actions of the Reserve Bank. Politicians grow nervous when policy decisions of the Reserve Bank may impact their chance of re-election.
So how does it work?
The Reserve Bank has control over the official interest rates. This falls under Monetary Policy. It has the power to raise or lower interest rates at its absolute discretion, which occasionally places it at odds with various political groups.
This is what we are witnessing today.
The term given to these actions by the Reserve Bank is Monetary Policy. This policy has been used to control inflation by reducing household spending. The Reserve Bank has increased the official interest rate from 0.10% in April 2022 to 4.35% in December 2023, where it remains today. As the cost of borrowing increases for banks, they often adjust their home loan interest rates to maintain their profit margins. This means that borrowers end up paying more for their loans.
Think of it this way:
If the price of ingredients, say flour & eggs, goes up, the cost of the final product, will also increase.
It is the same with home loans.
Importantly, it is worth highlighting that the socio-economic burden of controlling inflation falls mainly on a small segment of our society who can least afford it. These are young families because they have the largest mortgages. This is how younger couples who are raising kids are saving Australia from inflation. And it’s not fair!
Is there an alternative to monetary policy?
The short answer is yes. The federal government has its own tool to control the Australian economy. It is called Fiscal Policy and can also be used to control inflation. It is the use of government spending and taxation to control the economy. For example, to reduce economic activity and therefore constrict inflation, a government may increase taxes and reduce its’ spending. This will act to slow economic activity. Equally, to increase economic activity the government can reduce taxes and increase its’ spending. Increased spending is also known as pump-priming the economy.
This is where the independence of the Reserve Bank becomes obvious. Fiscal policy is often closely related to political priorities rather than what might be the most appropriate, but less-popular, decision. Alternatively, the Reserve Bank remains independent of political bias, with complete focus on what it believes is best for Australia.
It’s your money and your future.
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