What actually is the RBA’s interest rate?
The Rerserve Bank of Australia’s (RBA) announced interest rate are not anywhere near the amounts the banks charge for money they lend through home loans, personal loans, etc. So what is the RBA interest rate then then? To fully understand what the RBA’s interest rates figure is, an understanding of Australia’s “cash rate” is required (cash rate = RBA interest rate). The RBA’s website defines the cash rate as
…the interest rate which financial institutions pay to borrow or charge to lend funds in the money market on an overnight basis.
So the target cash rate (and the RBA official interest rate) is the RBA’s ideal interest rate to implement monetary policy (that is to combat inflation and ensure sustainable economic growth). The target cash rate is exactly that, a target the RBA aims to achieve and works towards.
What is its purpose and role?
It is a form of policy to ensure inflation grows at a sustainable pace (inflation being a measure of the purchasing power of your money; i.e. the same good or service costing more in the future). The target cash rate can also be used, among other things, to incentivise growth and to boost consumer confidence.
How is the RBA’s interest rate (target cash rate) calculated?
How does the RBA achieve and influence the cash rate? The RBA does so by controlling the supply and circulation of funds (and securities also). The RBA controls the rate by actively trading; they buy or sell the securities and add or withdraw funds (money). With an understanding of simple economics and principles of supply and demand, one can appreciate that by withdrawing funds from circulation in Australia the RBA indirectly increases the cost to obtain it. In a nutshell, when the RBA wishes to increase the cash rate/interest rate they reduce the amount of money available to banks (withdraw funds). Banks of course lend out at a higher rate due to risk and profit goals, among other things.
Read more by visiting the RBA website on monetary policy.