Monetary policy

Main purpose:

• Stability of the currency in Australia: low and stable inflation rate
• Full employment
• Welfare:

Inflation rate in Australia should be at 2 - 3% on average and it has a medium-term flexible rate. That is to keep the in inflation low and allow flexibility for the Reverse Bank Board to make monetary policy decision.

When the economy grows too slowly because of weak demand, the Reserve Bank can loosen monetary policy, such as by lowering the cash rate to stimulate economic growth and employment. On the other hand, when the economy grows too quickly because of excessively strong demand, the Reserve Bank can tighten monetary policy, such as by raising the cash rate to dampen economic activity and contain inflation.

Why raising the cash rate?

“A cash rate is the interest rate that a central bank – such as the Reserve Bank of Australia or Federal reserve – will charge commercial banks for loans. The cash rate is also known as the bank rate or the base interest rate.”

While commercial banks are free to set their own interest rates for borrowing, the rates that they charge on loans and offer on savings tend to be derived from the cash rate.

This means that central banks can use cash rates to encourage or discourage consumer spending, depending on the state of the economy.