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Interest rates, an effective tool to contain inflation?

Team Veye | 09 May 2022

Interest rates, an effective tool to contain inflation?

Inflation occurs when an economy grows due to increased spending without an accompanying increase in the production of goods and services. When this happens, prices rise and the currency within the economy is worth less than it was before. The consumer's buying power declines because the rate of wage and income growth does not keep up with the rate of inflation.

Every government wants to maintain a stable and growing economy backed by a good financial system. The Reserve Bank of Australia has the responsibility of maintaining the stability of the financial system in the country.

The Bank has a duty to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people. It does this by implementing its monetary policy using a variety of tools. The primary tool of monetary policy is the cash rate target.

To achieve its objectives, the Bank has an inflation target. Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.

When the government wants to boost spending, it lowers the interest rates. Doing so, makes borrowing relatively cheap and encourages higher levels of consumption and investment. Cheaper borrowing can lead businesses to take out loans and expand. Lower mortgage rates, typically lift home sales.

On the other hand, interest rate increases help contain inflation as consumers spend less when the cost of borrowing rises.

Recently, RBA increased the cash rate for the first time in more than eleven years. It hiked the cash rate by 0.25% taking it to 0.35% and signalling more rate hikes ahead.

All four of Australia's major banks are passing on the rate increase to their customers. Commonwealth Bank Australia announced that it would be increasing its home loan variable interest rates by 0.25 per cent per annum, which will come into effect on May 20. While ANZ will also increase variable interest home loan rates by 0.25 percent from May 13, Westpac has also increased its home loan variable interest rates by 0.25 per cent for new and existing customers. NAB increased the standard variable home loan by 0.25 per cent to 4.77 per cent and the reward saver bonus interest rate is increased by 0.25 per cent.

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