The RBA. Or, the Reserve Bank of Australia. Most people probably have a vague idea of what they are. Australia’s central bank, right? But what do they do? The RBA, in their own words, “contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” But how do they do that? Why is this information important to me? Keep reading to find out!
The RBA is Australia’s central Bank. But what is a central bank? (1)
A central bank is an institution that manages the currency and monetary policy of a country. They oversee the commercial banking system, and issue and regulate currency. A source of pride for most Australians is our stupendous polymer banknotes. We have the RBA to thank for that! They were the first to develop polymer banknotes.
Central banks are not commercial banks; they are instead important for maintaining financial strength and economic stability – looking after our economy. They do this by controlling inflation, or the increase in the average price level of goods and services. We will take a look at how the RBA goes about fulfilling its roles.
A Macroeconomic Look
The RBA controls the cost of borrowing in our economy by setting a cash rate and engaging in open market operations. The cash rate is the rate of interest the RBA charges on overnight loans to commercial banks. It has an indirect influence on the interest rates because it affects the affordability of credit for the banks. Banks can then pass on the effects of the cash rate (through an increase or decrease to interest rates) to customers. If the RBA increases the cash rate, banks increase their interest rates and the cost of taking out a loan increases. This also ends up causing inflation to fall (a decrease in the average price level) as people spend less and the demand for goods and services fall.
Open market operations are transactions in domestic financial markets to ensure that the banking system has enough liquidity, or the availability of assets that can easily be converted to cash, and therefore to ensure that the payments system functions smoothly. Open market operations can decrease the interest rates if the RBA buys government bonds, which increases the amount of money in circulation and decreases the interest rate. When it needs to absorb money to reduce inflation, the RBA will sell government bonds on the open market, which increases the interest rate and discourages borrowing.
This information is all well and good, but most people don’t care about the large- scale (macroeconomic) effects. What does this mean for me?
Have you ever bought something? Then what the RBA does affects you! The RBA influences the interest rate which, as discussed earlier, affect the average price level, the increase of which is called inflation.
Many people take out long- term loans, such as mortgages, to fund big purchases, such as cars. If the RBA decides inflation is too high and wants the interest rate to increase, that will increase the cost of the loan and that big purchase will become in effect more expensive. Thinking of selling a home? You may want to wait until the interest rate is low (like right now – historic lows), so your house sells for the most money, since house prices generally rise when the interest rate is low, and vice versa.
Most people have mortgages on their houses to pay off. A decrease in the cash and interest rate means that there is a lower rate on a mortgage and repayments get cheaper. However, a decrease in the cash and interest rate also is bad news for savers. A lower interest rate means you earn less interest on the money in your bank account.
As you can see, as simple cash rate cut or rise is not that simple – it can affect you in many ways! Generally, when the RBA cash rate is higher, banks’ lending and deposit rates will be higher. The same applies when the RBA cash rate is lower; banks’ lending and deposit rates will also be lower.
Given the current situation, can the RBA influence interest rates go negative? (2)
Indeed they can. Negative interest rates occur when borrowers are paid interest rather than them paying interest to lenders. They rarely happen, but when they do, it usually happens during a deep economic recession where consumers have to be given that big incentive to spend money, where previous interest rate drops haven’t been enough and the central bank runs out of policy options to stimulate the economy. The negative interest rate can be an incentive for banks to make loans during a period in which they would rather hoard and hang on to money. By charging banks to store their reserves at the central bank, they are encouraged to lend more.
However, some economists worry that negative interest rates can have unintended consequences. If the situation is dire enough, savers could simply withdraw their money from their bank account and physically keep their cash with them. The lower amount of cash in banking system could lead to a rise in interest rates (as banks don’t have enough money to loan), which would forgo any advantage gained. For interest rates to go negative, the situation would have to be quite grim and all other options to stimulate the economy would have been tried. Philip Lowe has stated that it was “extraordinarily unlikely that we would have negative interest rates” in Australia.
Key Take- Away Points
- The RBA, or Reserve Bank of Australia, is Australia’s central bank
- Their job is to look after our economy
- They set the cash rate and engage in open market operations to influence interest rates and inflation
- This can have a litany of affects on most people, chiefly their loans and deposits.
- A central bank, like the RBA, are tasked with managing the currency and monetary policy of a country.
- They also oversee the commercial banking system, and issue and regulate currency.
- Interest rates could go negative. Negative interest rates involve borrowers getting paid interest rather than them paying interest to banks.
- However, it would have to be a dire economic situation and all other options must have been tried to stimulate the economy for interest rates to go negative.
Year 11 MHS Economics 2020 