Interest Rates – Tomorrows Problem

Interest rates will get a lot of airtime over the next couple of days. So what are they and why do they matter.

Interest Rates
The best way to think about interest rates is as a proxy for the cost of money. When interest rates are high, money is expensive. Alternatively, money is cheap when interest rates are low. And if money is expensive, people are less likely to use it, so they’ll save it. If money is cheap, it has less value to people, so they are more likely to spend it.

The Reserve Bank of Australia (RBA) knows this, and they change the level of interest rates to try and manipulate the way we spend and save…..  

The RBA’s main job is get the cost of money (ie interest rates) at a level which encourages people to spend, but not too much, and not  too little either. If people spend too much, it could lead to prices going up (ie inflation), making things more expensive which people don’t like. On the other hand, if people spend too little, it could lead to prices falling, businesses losing money and people losing jobs, which is, as they say hashtag not ideal #notideal. So what they are looking for is that goldilocks level of interest rates, where all those things kinda balance themselves out.

So what do they look at?
There are a whole heap of different measures the RBA will look at to try and work this out. The single most important one is the level of inflation in the economy. Inflation, is a measure of how the price of the things you buy in your day-to-day life are changing. If they are going up, it’s called inflation, if they are going down, it’s called disinflation.  A little bit inflation is good, too much of it is bad. The reason inflation is good, is that prices going up, encourages people to spend today, rather than tomorrow. In the alternative, if you thought prices in the future were going to be lower than they are today, you would delay spending today. And if prices are continuously going down, you would delay your spending indefinitely. And if you’re not spending, business aren’t earning revenue, can’t pay their staff, and ultimately will have to let their staff go. To quote Donald Trump “BAD!”.

little bit of inflation therefore is a good thing, to encourage people to be spending today. The generally accepted level of “good inflation” as agreed by all the propeller heads of economics around the world is 2-3% per year. And that’s what the RBA targets too. In fact it’s actually in their official doctrine. See here.

And then…
So, on the first Tuesday of every month (which is tomorrow) the people who make up the RBA get to together to make one of three decisions:
1/ Increase interest rates (which they will do, if they are trying to encourage spending)
2/ Decrease interest rates (which they will do, if they are trying to discourage spending)
3/ Leave interest rates unchanged (which they will do, if they will do if they in general ok with everything)

Tomorrow, they will choose option 3. Great if have a mortgage. No so great if you’ve got savings.

Anyway, that’s 5 minutes. Hope it helped.

Categories: Investing

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