Show notes – The Role of the Reserve Bank of Australia (RBA), Why they Target Interest Rates & Why we Need Inflation, Just not too much! (Ep. 219)

Previously known as “The Property Planner, Buyer and Professor”

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Highlight segments:

7.25 – Cate points out that pre-2022, Australia’s inflation was under the target band and Dave expands

9.25 – Mike contemplates a new $100 note design

10.38 – Cate recalls her Dad’s nervousness about her proposed debt back in 1997

16.32 – Mike touches on the uncertainty that can be created when states and federal government start ‘tinkering’ around the edges

22.00 – Dave explains why the target inflation band is 2% – 3%

24.10 – Dave sheds light on some of the RBA open market operations

25.27 – Mike gives his take on Quantitative Easing, aka “Money Printing”.

29.25 – “Discount window lending”, and “forward guidance”, two concepts Dave shares

37.09 – The Trio ponder the outcomes from rising rates

44.40 – Gold Nuggets

Show notes:

1. What is the RBA’s mandate and how does it relate to inflation?

The Reserve Bank Board’s obligations with respect to monetary policy are laid out in Sections 10(2) and 11(1) of the Act. Section 10(2) of the Act, which is often referred to as the Bank’s ‘charter’, says:

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

  1. the stability of the currency of Australia;
  2. the maintenance of full employment in Australia – “Everyone who wants a job, has a job,” states Dave.
  3. the economic prosperity and welfare of the people of Australia.

The RBA’s primary objective, as set out in the Reserve Bank Act 1959, is to maintain price stability:

  1. When prices are stable, it provides certainty for consumers and businesses in planning their spending, investment, and saving decisions. It also helps maintain the purchasing power of money over time.
  2. Price stability = keeping inflation low and stable over the medium term

These responsibilities are within the RBA remit: 

  • Monetary Policy: The RBA uses monetary policy tools, primarily through adjusting the official cash rate, which influences short-term interest rates and helps control inflation and support economic growth.
  • Currency and Payments System: Issuing and managing the Australian dollar currency. It aims to maintain confidence in the currency and ensure the smooth functioning of the payments system, which involves overseeing the operation and stability of Australia’s financial infrastructure.
  • Financial Stability: Promote the stability and resilience of the financial system. It monitors and assesses risks to financial stability, implements policies and regulations to address those risks, and collaborates with other regulatory bodies to ensure the overall stability of the financial sector.
  • Economic Research and Analysis: Conduct economic research and analysis to gain insights into the Australian and global economy. This research informs the bank’s decision-making process regarding monetary policy and other areas of its mandate.
  • Banking Services: Provides banking services to the Australian government, other financial institutions, and some international organisations. These services include managing the government’s bank accounts, issuing government debt, and facilitating the smooth functioning of the financial system.

2. Why do we need inflation?

  1. Encourages Spending and Investment: Inflation can incentivize consumers and businesses to spend and invest rather than hoard cash. When people anticipate rising prices, they are more likely to make purchases and invest their money in assets or projects that have the potential to generate returns. This increased economic activity can stimulate demand, drive production, and contribute to economic growth.
  2. Supports Debt Repayment: Inflation can make it easier for borrowers to repay their debts. When there is inflation, the value of money decreases over time. As a result, borrowers can repay their debts with money that has less purchasing power compared to when they initially borrowed. This can provide relief to individuals and businesses burdened with debt obligations.
  3. Facilitates Wage Adjustments: Inflation can help in wage adjustments and maintaining labor market flexibility. As prices rise, wages tend to adjust to reflect the increased cost of living. This flexibility allows wages to respond to changes in supply and demand conditions in the labor market. It can help ensure that workers’ wages keep pace with the overall price level and maintain their purchasing power.
  4. Encourages Long-Term Investment: Inflation can incentivize long-term investment over short-term speculation. When inflation erodes the value of cash holdings, investors are more likely to invest in productive assets such as stocks, bonds, or real estate to preserve or grow their wealth. Long-term investments contribute to capital formation and can support economic development and productivity improvements.
  5. Provides Monetary Policy Flexibility: Inflation allows central banks to use monetary policy tools to manage the economy. By adjusting interest rates, central banks can influence borrowing costs, control money supply, and steer the economy towards desired outcomes such as price stability and sustainable growth. Inflation provides a reference point for central banks to set their policy rates and implement appropriate measures.

It’s important to note that the benefits of inflation are contingent on it being moderate, stable, and anticipated, which is why the RBA set a target for inflation of 2-3%.


3. Why is the inflation target set at 2-3%

The Reserve Bank has an inflation target to achieve the goals of price stability, full employment, and prosperity and welfare of the Australian people.

  1. Australia’s inflation target is to keep consumer price inflation between 2–3%, on average, over time. The inflation target is flexible and allows for temporary fluctuations in inflation above or below the target.
  2. Low and stable inflation reduces uncertainty in the economy, helps people make saving and investment decisions, and is the basis for strong and sustainable economic growth.
  3. The Reserve Bank adopted the inflation target in the early 1990s.

A target range of 2-3 percent inflation is often considered a good target for central banks for several reasons:

  1. Price Stability: A moderate level of inflation within the target range promotes price stability. Price stability is desirable because it allows consumers and businesses to plan their economic decisions with confidence. When inflation is low and stable, it reduces uncertainty and minimizes the disruptive effects of rapidly changing prices.
  2. Facilitates Monetary Policy: Inflation within the target range provides central banks with a meaningful reference point for conducting monetary policy. It allows them to set policy rates and implement measures to manage the economy, such as adjusting interest rates and controlling money supply. Having a clear inflation target helps central banks communicate their policy objectives and anchor inflation expectations.
  3. Avoids Deflationary Pressures: Targeting a positive inflation rate helps to avoid deflation, which is a persistent decline in prices. Deflation can lead to economic stagnation and discourage spending and investment. By setting a positive inflation target, central banks aim to prevent deflationary pressures and maintain a more favorable economic environment.
  4. Supports Real Income Growth: A target range of 2-3 percent inflation can align with a goal of supporting real income growth. When wages and income increase at a similar or higher rate than inflation, it allows individuals to experience a growth in their purchasing power and maintain or improve their standard of living. It helps ensure that wage growth outpaces the erosion of purchasing power caused by inflation.
  5. International Consistency: A target range of 2-3 percent is commonly used by central banks in many countries. Having a consistent inflation target across countries can facilitate international trade and investment, as it provides a basis for comparison and stability in economic relations.

4. Why does the RBA adjust the cash rate to manage inflation?

When inflation is above the target range, the RBA may raise interest rates to reduce spending and dampen inflationary pressures. Conversely, when inflation is below the target range, the RBA may lower interest rates to stimulate spending and support economic activity.

How increasing the cash rate achieves this: 

  1. Reducing Aggregate Demand: By increasing interest rates, central banks make borrowing more expensive for businesses and individuals.
    1. This, in turn, reduces spending and investment in the economy, leading to lower aggregate demand.
    2. When demand decreases, there is less pressure on prices to rise, thus helping to alleviate inflationary pressures.
  2. Controlling Money Supply: Higher interest rates can incentivize individuals and businesses to save more rather than spend or invest.
    1. By controlling the money supply, central banks aim to limit excess liquidity, which can contribute to inflationary pressures.
  3. Attracting Foreign Capital: Raising interest rates can make a country’s currency more attractive to foreign investors seeking higher returns on their investments.
    1. This increased demand for the currency can strengthen its value relative to other currencies.
    2. A stronger currency can reduce the prices of imported goods, which helps curb inflation, particularly if imported goods are a significant part of an economy’s consumption.
  4. Anchor Inflation Expectations: Expectations play a crucial role in inflation dynamics.
    1. If people expect prices to rise rapidly, they may adjust their behavior accordingly, demanding higher wages or raising prices, which can fuel inflation further.
    2. By raising interest rates, central banks signal their commitment to controlling inflation and anchor inflation expectations.
    3. This can help break the cycle of rising prices by influencing people’s behavior and dampening inflationary pressures.

5. Other monetary policy adjustments reserve banks may make

Dave sheds light on some of the RBA open market operations, and makes the point that fiscal policy must work in tandem with monetary policy.

  1. Central banks conduct open market operations by buying or selling government securities, such as bonds, in the open market.
    1. Purpose: manage the money supply and influence short-term interest rates, to achieve economic outcomes such as controlling inflation or stimulating economic growth
      1. Buying Securities: When a central bank buys government securities from financial institutions, it injects money into the economy. This increases the amount of money available for people and businesses to spend. With more money circulating, people tend to buy more goods and services, which stimulates economic activity. Increased spending can lead to higher demand for goods, and if the supply cannot keep up, prices may rise (inflation)
        1. This increase in liquidity can lower interest rates because there is more money available for lending.
        2. Lower interest rates can make it cheaper for businesses to borrow money, including issuing bonds or obtaining loans, which can provide businesses with access to capital for investment and growth.
      2. Selling Securities: On the other hand, when a central bank sells government securities, it takes money out of the economy. This reduces the amount of money available for spending. When there is less money circulating, people may be less inclined to spend, which can help control inflation. If people are not spending as much, there is less demand for goods, which can put downward pressure on prices.
    2. What types of securities: focus on short term government securities such as Treasury bills or short-term bonds.
    3. Scale and Scope: open market operations are more commonly used by central banks as part of their regular monetary policy toolkit to manage the money supply and influence short-term interest rates in more stable economic conditions.

Mike shares with us all his explanation of Quantitative Easing, aka “Money Printing”. He demystifies this concept superbly by outlining the drivers for QE, the purpose of QE, and some of the outcomes of QE. The unintended consequences are something we need to consider and Cate presses Mike on this.

  1. In times of economic downturn or deflationary pressures, central banks may implement QE, by purchasing long-term government bonds or other assets from financial institutions.
    1. Purpose: provide monetary stimulus during times of economic downturn or deflationary pressures, inject liquidity into the economy (similar to Open Market Operations) and stimulate lending and investment. The goal is to boost economic activity, prevent deflation, and support overall economic recovery.
      1. Inject money into the economy – similar to open market operations
      2. Stimulating Lending and Investment: When financial institutions receive money from the central bank through the purchase of assets, they have more funds to lend to businesses and individuals. This increased lending and investment can stimulate economic activity, as businesses may have more access to capital for expansion and individuals may have more money to spend.
    2. What types of securities: a wider range of assets than Open Market Operations, including long-term government bonds, corporate bonds, mortgage-backed securities, or other assets from financial institutions. By purchasing these longer-term assets, central banks aim to lower long-term interest rates and provide a more direct boost to lending and investment in the economy.
    3. Scale and Scope: Quantitative easing is often considered a more expansive and unconventional monetary policy tool compared to open market operations. QE involves larger-scale asset purchases, typically over an extended period, and may be deployed when traditional interest rate adjustments are insufficient to stimulate the economy. It is typically used during severe economic downturns or when interest rates are already near zero.


  • Reserve Requirements: Central banks set reserve requirements, which are the amount of funds that banks must hold as a percentage of their deposits. By increasing reserve requirements, central banks reduce the amount of money available for lending, which can help curb inflationary pressures. Lowering reserve requirements has the opposite effect, stimulating lending and economic activity.

In short, it means less or more money is borrowed therefore reducing spending and investment.

  • Discount Window Lending: Central banks offer short-term loans to commercial banks through the discount window. By adjusting the interest rate charged on these loans, central banks can influence the cost of borrowing for banks. Increasing the discount rate makes borrowing more expensive, reducing liquidity and potentially curbing inflation. Conversely, lowering the discount rate encourages borrowing and can stimulate economic activity.

Again, it means less or more money is borrowed therefore reducing spending and investment.

  • Forward Guidance: Central banks provide forward guidance by communicating their intended monetary policy actions or future economic outlook. This helps shape market expectations and influences borrowing and spending decisions. By signaling their commitment to price stability and controlling inflation, central banks can anchor inflation expectations and guide behavior in a desired direction.

6. Fiscal policy measures reserve banks can use

  1. Government Spending Cuts: Governments can reduce their expenditure on goods, services, and infrastructure projects. By cutting spending, the government reduces the overall demand in the economy, which can help to mitigate inflationary pressures. This measure aims to bring down aggregate demand and control inflation.
  2. Tax Increases: Governments can raise taxes on individuals and businesses. Higher taxes reduce disposable income, which in turn curbs consumer spending and lowers aggregate demand. By increasing taxes, governments can help rein in inflationary pressures by reducing spending power.
  3. Tightening Monetary Policy Coordination: Fiscal policy measures can be coordinated with monetary policy actions, such as interest rate hikes by the central bank. By aligning fiscal and monetary policy, governments can reinforce the efforts of the central bank to control inflation. This coordination helps to create a more comprehensive and effective anti-inflationary strategy.
  4. Supply-Side Policies: Governments can implement supply-side policies to address inflation. These policies aim to increase the production and supply of goods and services. Measures like reducing regulatory barriers, promoting investment in infrastructure, and enhancing productivity through technological advancements can help boost the aggregate supply. By increasing supply, the economy can better meet the demand for goods and services, potentially easing inflationary pressures.
  5. Wage and Price Controls: Governments can impose controls on wages and prices to limit inflation. These controls can include direct intervention in setting wage and price levels, often through legislation or agreements with labor unions and businesses. The objective is to restrict the increase in wages and prices, thereby containing inflation. However, wage and price controls can have unintended consequences and distortions in the market, so they are not commonly used and are often considered temporary measures.

7. Outcomes from rising rates to reduce inflation

  1. Reduced Consumer Spending:

Increasing interest rates make borrowing more expensive for consumers, including mortgages, auto loans, and credit cards.

  • Higher borrowing costs can discourage consumer spending, particularly on big-ticket items, leading to a decline in consumption.
  • This reduction in consumer spending can have a dampening effect on economic growth.
  1. Decreased Business Investment:

Higher interest rates can also raise the cost of borrowing for businesses.

  • This can discourage investment in new projects, expansions, and equipment purchases.
  • When businesses cut back on investment, it can lead to lower economic activity and potential job losses.
  1. Slower Economic Growth:

The combination of reduced consumer spending and decreased business investment can lead to slower economic growth.

  • When spending and investment decline, overall aggregate demand weakens, which can result in a slowdown in economic activity.
  • This can affect various sectors of the economy, including retail, construction, and manufacturing.
  1. Increased Unemployment:

If businesses curtail investment and reduce production due to higher borrowing costs, it can lead to job losses and increased unemployment.

  • When economic growth slows, companies may need to downsize their workforce to adjust to lower demand and reduced profitability.
  1. Improved Price Stability:

The adjustment of interest rates to address inflation aims to maintain price stability.

  • By increasing interest rates, central banks aim to reduce inflationary pressures and keep price growth in check.
  • If successful, this can help preserve the purchasing power of money and promote a more stable economic environment.

Gold Nuggets:

Dave Johnston’s gold nugget: Through understanding the risks that sit in the economy, investors can be better placed to understand the market long term. The benefits of long term planning hinge around managing risk.

Mike Mortlock’s gold nugget: “You can see that there’s a very complex interplay between things”, and Mike believes that every property investor should familiarise themselves with the RBA meeting discussions. The implications discussed in the RBA meeting minutes do have a real effect on property investors. Knowledge is power when it comes to making long term property decisions.



Ep. 89 – Capital growth – what increases property value?

Ep. 119 – How supply and demand dictates market movements

Ep. 155 – Plotting Australian property market movements from 1970 to now

Ep. 158 – How interest rate cycles have impacted the property market since 1990

Ep. 217 – the inflation conundrum; unravelling it’s causes and consequences

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