25 August 2008
Most homeowners are rejoicing the Reserve Bank of Australia’s (RBA) decision to drop official interest rates by one quarter of a percent. Current speculation is that we will see yet another decrease before year end. But how are interest rates determined and why are they changed?
The Australian Government’s policies and decisions to raise and spend money are referred to as fiscal policy. For example the changes to the personal income tax rates are part of fiscal policy.
Monetary policy is the action taken by the central banks, for example increasing official interest rates is part of monetary policy.
In Australia the Federal Government appoints the RBA Board. This board meets monthly to discuss monetary policy and set interest rates. Before the board meets it is supplied with vast amounts of current economic data. Board members use this information to assist in making their decisions.
Changes in interest rates are designed to stimulate or dampen the economy. When setting interest rates the RBA’s core objective is to maintain low and stable inflation.
Changes to official interest rates are designed to affect the bank’s margins. But when official interest rates change it does not necessarily mean that the banks and lending institutions pass changed interest rates onto lenders. If banks decide not to pass a lower rate change onto lenders, they would receive a lot of criticism from the Government, RBA board, media and the consumer.
