Why are interest rates important?

From the perspective of a person with a mortgage, interest rates are extremely important because they determine the amount of money which needs to be paid back on a variable interest rate loan. Australia is a country where mortgages are one of the main draws on household income and if a person is unable to pay their mortgage it has an enormous impact on the rest of their life. As interest rates rise. At a broader level, interest rates are a central element of the control of the economy because in contemporary industrial economies, the raising of interest rates can be used in order to control inflation, overheating and unsustainable growth in the economic system. When interest rates are too high, businesses and individuals will cease borrowing and stifle growth in the economy.

How are interest rates set?

Interest rate policy in Australia is set by the Reserve Bank of Australia. Historically, interest rates have been controlled by the Reserve Bank cash rate because this is the rate at which the Reserve Bank lends money to the major banking and financial institutions and this therefore determines what banks will charge their customers in order to borrow money that has been lent to them by the government.

The Reserve 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:

(a) the stability of the currency of Australia;
(b) the goal of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.’