Wednesday Q&A – The RBA

Hi
Hi.

Can I be honest?
That’s really a question only you can answer son.

Wait……. what?! Dad?! Is that you??
Um… no. It’s a figure of speech.

<insert sad-face emoji> 
……

<wipes tear from eye>  *cough* 
<checks watch>

Look, I’m getting pretty sick of all this conversation about interest rates. 
Thanks for your honesty. Allow me to return the favour. I’m getting sick of all your questions. But we both push through because that’s what we do. I know why you’re bringing this up though. It’s because you saw the Reserve Bank of Australia (RBA) announce yesterday that they’ll again be leaving the official interest rate unchanged at 1.5%.

Exactly. I just don’t get why you spend so much time focusing on them. Why are they so important?
They are important because changes in interest rates have such large effects on the way people spend. And as you know, one person’s spending is another person’s income. So if people’s spending changes, so too will people’s incomes.

For example, say you have a 30-year, 500,000-dollar mortgage. If interest rates increase by 0.25%, your repayments will go up by around 100 dollars a month. Doesn’t sound like much right? A 100-dollar increase should be pretty manageable for most people. But that’s still 100 dollars less you have to spend. And your spending is someone else’s income. So that’s 100 dollars in lost income for someone else.

The thing is, there are over 1.7 trillion dollars in mortgages outstanding in Australia. On 1.7 trillion dollars, a 0.25% increase equates to about 350 million dollars in additional mortgage spending. Each month. And if Australians are spending 350 million dollars morea month on their mortgages, it means there is 350 million dollars less a month which can be directed towards almond milk Frappuccino’s and organic, carbon neutral chicken products. 350 million is a really big number. Over a year, that number gets even bigger.

4.25 billion. 4.25 billion dollars in reduced spending and therefore 4.25 billion dollars in reduced incomes.

Are you starting to see how small changes in interest rates can have dramatic effects on spending in the economy?

Huh. What do you know. I guess I am. 
Indeed. But mortgages aren’t the only things interest is paid on. There’s also credit cards and personal loans and car loans too. And that’s just for individuals. Don’t forget about businesses who tend to fund much of their operations using debt. All told, there’s about 2.8 trillion dollars in personal and corporate debt outstanding in Australia. And every one of these loans will have their interest rates repayments affected should the RBA decided to change the official rate of interest in Australia.

That is why we care. And why you should too.

Thanks
You’re welcome. Look, I know I don’t say this enough, but I’m really proud of you. Anyway, thats 5 minutes. Hope it helped.



Categories: Investing, Macro Economics

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