Monetary Policy

The Reserve Bank is responsible for Australia's monetary policy. Monetary policy involves setting the interest rate on overnight loans in the money market (‘the cash rate’). The cash rate influences other interest rates in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately the rate of inflation.

In determining monetary policy, the Bank has a duty to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term. Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.

Monetary Policy Framework

Watch video: Monetary Policy Framework

Transcript

Philip Lowe, Governor (2016 – Present)

The Reserve Bank's Charter was written in 1959. It's broader than the charter of most other central banks, it's got three key elements. The Reserve Bank is responsible for low and stable inflation, for full employment, and promoting the general welfare of the Australian people. I'm glad we've got this broad mandate, it's, as I said, it's broader than most other central banks, many other central banks just have a mandate to control inflation. In the end, low inflation is not the goal in and of itself, it's delivering low inflation to promote the economic prosperity of the Australian people.

The Reserve Bank Board sets the cash rate on the first Tuesday of every month. The cash rate is the rate that banks use to lend to one another in a short-term money market, but it has a very large effect on mortgage rates in the economy, on the rates that people get on their savings, and affects asset prices and the exchange rate, so it's a very important interest rate.

Sometimes, we need to raise interest rates to achieve those objectives. If the economy's growing very strongly, demand's very buoyant and that's pushing up prices, we might need to raise interest rates to slow the economy, to get things back onto an even keel. Conversely if things are weak and demand is not very strong and inflation's low, we might need to lower interest rates to stimulate demand and get inflation back up towards the target.

When we change interest rates, people obviously notice in their mortgages, and that affects how much they spend. When rates are going up, they have less to spend, and when rates are going down they have more to spend. Changes in the cash rate also affect the exchange rate. If we raise interest rates, the currency tends to appreciate, and when we lower interest rates the currency tends to depreciate. Changes in interest rates can also affect people's confidence. In some circumstances, lower interest rates makes people feel happier, in other cases it, higher interest rates make people feel less happy, and so that affects their spending. Changes in interest rates also affect asset prices. When we have lower interest rates, that tends to push up asset prices, and if asset prices are higher, people might feel wealthier, and if they're wealthier, they might spend more, and conversely, if higher rates might mean lower asset prices, then people don't feel as confident and they don't spend as much.

Our Board is made up of mainly outside people, who are either business people or people who have experience in other areas of public policy or public service. And I think that's really valuable. What I notice about business people and people who have the broader experience is they're very good at making decisions under uncertainty, and much of what the Reserve Bank Board is doing is making a very important decision in a quite uncertain world, so we're trading off things all the time and we're trying to make the best decision in the welfare of, best welfare of the people of Australia. And the business people and people with outside expertise are very good at doing that. Daresay they're actually better doing it than economists, so I like, kind of having this broad perspective on our Board, I think it also helps the legitimacy and the public accountability of the Board, it's much better to have the interest rate decisions made by this broad group of people rather than primarily made by technical, academic economists. So I'm a strong fan of our current board structure, although it's quite different from the boards of most other central banks.

At a very practical level, we operate a flexible medium-term inflation target. Our objective is to deliver an average rate of inflation for the community between two and three percent, over time. We're prepared to allow the inflation rate to move up and down over time, but we want people to be confident that over time, inflation in Australia will be two point something. And if people are confident of that they can go about making their decisions about saving, investment and spending, with assurance that inflation will be low and stable, the value of their money will be protected because it won't be eroded by inflation, then they can have certainty about what the price level will do over time.