Why understanding monetary policy can help you save money, and how

Here at Mozo, we give a lot of airtime to explaining decisions from the Reserve Bank of Australia (RBA). This is because the primary responsibility of the RBA is to steer Australia’s monetary policy, which influences every part of our economy. 

From home loans to bank accounts, the RBA plays a critical role in how we all save (or spend) our hard-earned cash. Even the cost of living can be affected by decisions from the RBA.

So in the spirit of saving money, let’s take a look at how monetary policy works, its impact on everyday Australians, and how you could use it to your advantage.

Monetary policy is the set of guidelines the Reserve Bank of Australia (RBA) uses to make decisions about the economy. As a central bank, the RBA's goal is to ensure the economic welfare of ordinary Australians by keeping the business cycle as smooth as possible. 

If you think of the Australian economy like a car, the RBA is the driver keeping the wheel steady so we can all get where we want to go.

If the economy is going strong and steady, it’ll leave things be and drive straight.

However, if the economy seems to be struggling or swinging out of balance, the RBA will course correct the car by changing its monetary policy. 

TIP: Monetary policy is different from “fiscal policy”, another common economic buzzword. Fiscal policy is how the government manages its money (such as the federal budget), while monetary policy is how the central bank manages the Australian economy at large.

Every month (except Januaries), the Reserve Bank board will meet and take a look at how the economy is going, like a driver checking the dash. How’s our speed? Are we drifting out of the lane? Any upcoming hills, dips, or potholes? The RBA will then make any adjustments necessary to keep our ride as smooth as possible.

These moves affect every passenger in the vehicle, so it’s to our advantage to know what the driver is doing and why.

Here’s what the RBA looks out for – and what we should, too.

• Inflation: what’s the speed of the car? Is the price of goods and services going up? If so, by how much? The RBA aims for an inflation rate of between 2-3%, because while it doesn't want the car to speed out of control, it also doesn't want it going too slow, either. Otherwise, we’ll never keep up with everyone else on the road.
  
• Currency: how fast are we going compared to other drivers? The RBA wants our sedan to keep pace with the bigger, flashier SUVs. So, it’ll have a look at the value and stability of the Australian dollar and whether we get a good exchange rate overseas, to make sure our car competes well with others on the road.
  
• Wage growth: have we got enough fuel? Think of consumer cash like fuel: the more cash consumers have, the more fuel in the tank. And since cars can’t go without petrol, the RBA ensures we have as much as we need. It does this by comparing incomes to inflation. If Aussies earn enough to afford basic necessities, we have enough fuel and the car is fine. However, if prices go up too fast, then the cost of living surges and the car breaks down.
  
• Employment rate: does everyone in the car have something to do? The RBA is a considerate driver, at least, in that it wants every passenger to be happy and occupied. So it’ll check how many people who want jobs, have jobs. Ideally, the unemployment rate should fall within the 3-5% range (considered “full employment” by the RBA). Too many people with jobs means consumers have too much purchasing and negotiating power, but not enough jobs means they have no power. 

If any of these indicators aren’t where they should be, the RBA board will nudge them back into place so we avoid a crash.

The primary tool the RBA uses to control monetary policy is the official market interest rate, also known as the cash rate. In our economic car, the cash rate acts like a brake pedal for the RBA to control our speed (economic inflation).

How does this work? The cash rate sets interest rates on the overnight funds banks lend each other to meet daily cash needs. However, banks also use it to set interest rates for variable home loans, savings accounts, and term deposits.

This has knock-on effects for consumers, since by changing the cash rate, the RBA controls whether it’s better to save or spend your money.

For example: if the car speeds because of runaway inflation, the RBA will pump the brakes by raising the cash rate. Variable interest rates go up, which makes home loans more expensive but deposits more attractive. So rather than borrow and spend, customers will be more likely to park their money in a savings account. This gradually slows the speeding car and keeps the cost of living down.

How home loan interest rates move with the cash rate:

On the other hand, if the economy lags, the RBA will cut the cash rate (releasing the brakes), making home loans cheaper and bank accounts less attractive, therefore encouraging people to spend.

RELATED: What's the current cash rate?

The last time the RBA cut official interest rates was in 2020, when the economy was desperately reeling from COVID-19 and needed an infusion of cash. Now that inflation has surged well-over its target max of 3%, the RBA has begun lifting the cash rate again to slow the economy down.

While decisions made by the Reserve Bank can feel distant from our normal daily lives, we’re all passengers in this car. Even if our hands aren’t on the wheel, we can still brace ourselves or lean into what’s happening.

Here’s what you can do to protect your finances whenever the RBA makes a move.

Inflation! Cash rate and cost of living going up

Uh-oh, the car’s going too fast. Groceries and fuel have become major drains on your budget. Even your HECS-HELP debt has ballooned. So the RBA hits the brakes to halt inflation. Now what? 

Because the cash rate has gone up, banks will start offering better interest on savings accounts and term deposits. This makes it an excellent time to see if you’re getting the best rates by comparing what’s out there. If you find something better, maybe it’s time to switch banks. 

RELATED: 10 easy ways to handle the rising cost of living

Alas, home loans will be getting more expensive, too. Variable offers will change pretty quickly, but over time, fixed rates will rise as well. Now’s a good time to get an offset account and repay as much of your principal as you can, since this lowers the amount of interest you’ll need to pay in future.

If you’re worried about making your repayments, you can stress-test your mortgage with a rate change calculator.

Things getting too costly? It could be time to switch and save. (Here are 4 signs you should break up with your lender, if you’re unsure).

At least we can thank pricey mortgages for dropping housing demand, which will eventually slow down Australia’s outrageous property prices. Good news for first home buyers!

As for transferring money overseas, RBA cash rate movements will usually cause dips in the Australian dollar, but global inflation can make money exchange rates highly volatile. If you’re hoping to wire money to relatives, or rely on international business, here’s a guide on what to look out for in an IMT provider.

How will a rate change affect your repayments?

Deflation! Or recession – either way, the cash rate got cut

Oh dear, the car has slowed down too much. The RBA has released the brakes and now we’re itching to go, go, go! 

Cash rate cuts mean cheaper interest rates on home loans. So while your savings may not earn you as much interest as they used to, mortgage rates will be quite low. If you’ve saved up enough for a home deposit, now’s a great time to shop for competitive home loans.

You could opt for a low variable rate, or if you find a good offer, fix your home loan to guarantee consistent repayments for the next few years.

However, if you’re not quite keen to spend all your hard-earned cash, there’s still plenty of ways to save. You could try your hand at share-trading, or take this time to consolidate your debt and improve your credit score. 

Meanwhile, review your monthly expenses. Could you get a better deal on your mobile plan? How about your energy bill? If your budget still doesn’t cut it, it may also be time to ask for a pay rise.

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