In July 2022, the Australian Treasurer, The Hon Dr Jim Chalmers, announced a review of the Reserve Bank of Australia’s (RBA) functions, mainly its monetary policy framework. The review has essentially been Federal Government’s response to public anger relating to RBA’s several, consecutive interest rate hikes over the past several months. To be exact, RBA’s cash rate, which influences other interest rates in the economy, such as housing loan rates, has increased steady from 0.10% in April 2022 to 3.6% by March 2023. That is, an increase altogether of 3.5% over a period of 10 months.
Like many other central banks, the RBA uses the cash rate as a monetary policy tool to manage the country’s rise in general price levels, in other words, inflation. Managing inflation is a core central banking function, unmanaged or ill-managed, it may have undesirable economic consequences like reduced purchasing power of consumers, particularly impacting those in low-income categories, reduced value of currency and possibly recession. So, the RBA’s action, it argues, has been necessary for the overall good of the economy.
The public, particularly mortgage holders have been up in arms about this – it is understandable. As the cash rate rises so do (usually) other interest rates in the economy like mortgage rates. Variable housing rates have doubled over this period from around 3% to around 6% The consequences of this for borrowers can be substantial, especially, those with larger loans. Public and mortgage holder anger is justified. This is especially so because RBA had communicated that it was not expecting to increase the cash rate until 2024.
RBA’s thinking and communication was based largely on the expectation that inflation was not going to move in this period beyond its 2-3% target rate. Actions taken remained fine until March 2022 when rates started rising sharply and rapidly to 7.8% by December 2022, currently at 7.4%. Many factors have contributed to this sharp rise, including the perhaps unexpected Ukraine war. But Australians have also contributed to this with their lavish spending post COVID-19. So, the best way, with the available tools, was to hike the interest rate, with the expectation that spending will fall and thus eventually price levels.
Public anger has been the fundamental reason for the review. However, the Australian public may have also contributed to the rising prices. So where does the fault lay and what to do about it?
A review of RBA’s functions is fine, to perhaps modernise the Bank, especially because there has not been one in decades, but the basis of that is debatable. Some may argue that the the review has been politicised, akin to “bank-bashing”. Of course, politicians will appease the voters. It may also be argued that RBA’s modelling, not including factors such as a possible war and luxurious spending post COVID-19, needs a review. The Bank could benefit from being a bit more cautious and skilful in communicating important messages to the public.
That, however, lays the fault squarely and only at RBA. But to be fair, let’s ask ourselves: more broadly, how has RBA performed in the past several decades? My suspicion is that the response will lean more towards “positive”. Do we really understand the mammoth tasks that central banks are charged with? Keeping Australia out of recessions, for one—a big tick! This is where an increased awareness and financial literacy education will be very useful.
Talking about awareness and education, financial literacy comes to mind. My own experience, talking to people with diverse backgrounds, is that even the more educated among us are not necessarily also aptly financially literate. This is backed by a recent national survey For example, while 94% of young Australians agreed or strongly agreed that it’s important to learn how to manage their money, only 42% felt confident or very confident doing so. It was, generally, younger Australians and women who did not perform as well on average on financial literacy and did not rate their own overall knowledge and understanding of financial matters as highly as older Australians and men. Further, many Australians approaching retirement age do not have a financial plan for retirement.
A more financially literate public will be better informed when making financial decisions including significant ones like borrowing to acquire a home. For example, they may not be too tempted to over-extend their borrowing capacity—usually, a reason for defaults, even in good times. For example, lenders and their borrowing related tools may encourage or indicate a borrowing capacity, based on current circumstances, including lending rates more than $1 million. A more financially literate borrower may be more cautious and thoughtful, deciding against borrowing an inflated amount—what if interest rates did rise, despite RBA’s predictions. A more financially literate public will better understand that spending extravagantly may spark inflation.
Dr. Parmendra Sharma 
is a Senior Lecturer in Griffith University’s Department of Accounting, Finance and Economics in Griffith Business School and teaches banking and finance. Dr. Sharma is the founding program director of Pacific Islands Centre for Development policy and Research and its precursors, South Pacific Centre for Central Banking and the South Pacific Studies Group.
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