How interest rates are really set and why it matters?
Introduction
It was a great honour to be a member of an expert webinar panel hosted by The Chartered Institute for Securities and Investment (‘CISI’) regarding how interest rates are actually set by the Reserve Bank of Australia (‘RBA’) and why it matters. Thanks to our generous host Mark Thomas FCSI and subject experts Tim Farrelly and Guy Debelle.
Key points covered in the session included:
Why interest rates matter
The challenge of managing a diverse economy
Inflation growth and stagflation
The push and pull of monetary policy vs. fiscal policy
Limits of policy tools
Global influences
Structural forces and trends
Investment perspectives
Highlights
The key highlights from the session were that interest rate decisions are far more complex than what the headlines of the daily news suggest. The RBA is not simply ‘holding’, ‘raising’ or ‘cutting’ interest rates at each meeting.
The RBA is considering and seeking to balance multiple challenges and opportunities, often with competing forces at play, to seek to promote the economic prosperity and welfare of the Australian people, both now and into the future.
A recap of the RBA’s primary aims are to provide:
Price stability: Aiming to keep consumer price inflation within a target range of 2 to 3 per cent over the medium term to preserve the value of money.
Full Employment: Keeping the labour market at the maximum level of employment consistent with low and stable inflation.
Multi-speed economy
One of the topics I led were the discussions around the challenges of the Australian ‘multi‑speed economy’. Different sectors (e.g. mining vs manufacturing), states (e.g. growing state economies vs recessionary state economies), regional influences (e.g. capital cities versus regional towns) and households (e.g. young families with a mortgage vs retirees with savings in investment accounts).
These various sectors of the Australian economy experience changes to interest rates very differently. For example, young family mortgage holders face cash flow pressure when rates increase versus retirees with no mortgage benefiting from higher cash account returns.
However, the RBA must set one rate for the entire economy which requires a careful assessment of multiple inputs and that whatever happens with rates, there will be parts of the economy impacted positively and negatively in the multi-speed economy.
Conclusion
Following robust discussion by the panel based on excellent questions from the audience the key takeaways from the session were:
Interest rate setting is complex, relies on human judgment, and is not formulaic.
The RBA balances multiple objectives under great uncertainty.
The setting of rates directly influence consumer finances, business investment, asset prices and currency exchange rates.
The uneven (multi-speed) economy, global forces, and structural trends make policy decisions highly difficult.
Monetary policy in Australia does not operate in isolation. Federal Government fiscal policy, global economic conditions and structural forces such as demographics and productivity all impact on how Australian interest rates are set.
Thanks to the Australian and New Zealand team of CISI for putting on such an interesting and thoughtful event and to Emerson da Silva and Diana Fernandes for helping provide input for this blog post.
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