Comments on: Interest Rate Hikes, Savers Rejoice!

By: jonk

jonk — Fri, 07 Mar 2008 19:35:42 +0000

Hey scotty

The key as dazza intimated is inflation. Inflation comes from new money entering the economy through the form of newly created debt. So if you reduce the amount of money coming into the economy through debt (businesses, credit cards, mortgages), and increase the amount going to service debt (ie. dead money) then you can help drop inflation.

By: Monetarist

Monetarist — Thu, 06 Mar 2008 04:45:20 +0000

Central bank monetary policy is a little bit more complicated than that…. When it ‘sets’ interest rates, the RBA targets the offical cash rate – which is the rate than banks charge each other for overnight loans. Banks have to maintain a certain amount of liquidty at the end of a day’s trading, and one way of ensuring this balance at the end of the day is by borrowing money from other banks overnight.

Inflation effectively occurs when the money supply of the economy grows faster than the production of goods and services. If there is more money ‘sloshing’ around, and no more goods to spend it on, then prices go up.

The RBA tries to reduce future inflation by reducing the amount of money in the economy. One way of doing this is by increasing the amount of money banks must hold at the end of each day. As money becomes scare (for things like loans), the cost of using that money – the interest rate – rises.

Sorry, am a professional economist and just get frustrated when people ‘bash’ the RBA for targeting ‘struggling’ people with mortgages. It is a little bit more sophisticated than that.

By: Scott

Scott — Wed, 05 Mar 2008 22:42:32 +0000

@young_dazza — thanks it makes sense.

I do work for an ASX-listed company though but they are debt free (as I was taught). No wonder they are working us hard on new projects :(

By: young_dazza

young_dazza — Wed, 05 Mar 2008 20:10:56 +0000

I believe that when the reserve bank increases interest rates it is mainly hoping to stop businesses from spending money on new projects (which is a major reason for inflation). Most businesses (ie big public companies listed on the ASX) have a significant amount of debt compared to savings, so new projects are usually funded by borrowing money. If interest rates are high then businesses are less likely to go ahead with this project as it may not be profitable for them at high interest rates.
Of course interest rates are a really blunt tool. It also affects consumer spending (as you observe, that doesnt stop everyone from spending), and hurts people who are barely struggling to pay off the mortgage (who werent spending lots of money anyway!).