Finance Finance News What does the RBA actually do? We explain

What does the RBA actually do? We explain

Dr Philip Lowe is the new boss of our central bank. Photo: Getty
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A new Governor has taken over control of the Reserve Bank – news that warrants a little explaining.

Dr Philip Lowe replaced the retiring Glenn Stevens on Sunday. He has been deputy governor of Australia’s central bank since 2012 and has worked there ever since leaving high school at the age of 17.

Treasurer Scott Morrison marked the occasion by issuing a new monetary policy statement, the nation’s seventh, jointly with the new Governor on Monday.

“The governor and I agree that now is not the time to be making any major exchanges in the composition of this statement nor is it the time to engage in any monetary policy setting experiments,” Mr Morrison said on Monday.

It may surprise Australians to learn that the RBA is mostly independent from government — although the Treasurer appoints six of its board members, and can complain to the Governor-General if he disagrees with its policies.

The Governor is also answerable to Parliament, which created the RBA in 1959 to take over crucial functions from the Commonwealth Bank. Australians will get their first close look at Dr Lowe in the governorship when he makes his maiden appearance before the Standing Committee on Economics on Thursday.

Before that happens, here is your primer on what the RBA will continue to do under Governor Lowe.

1. Target inflation

As noted in the memorandum between Treasurer Morrison and Governor Lowe, the basis of Australia’s monetary policy is the inflation target. This has been so since 1996.

‘Monetary policy’ is what central banks do to protect and guide their economies. It is different from ‘fiscal policy’, which is what governments do to affect the economy.

It is the opinion of the RBA that targeting the Consumer Price Index (CPI) is the best way to meet the three aims set for it by Parliament: (1) stability of the currency, (2) maintenance of full employment, and (3) the economic prosperity and welfare of the Australian people.

Hyper-inflation erodes the value of money, sometimes to almost nothing. Photo: Getty
Hyper-inflation erodes the value of money. Photo: Getty

Under the old memo, the central bank pledged to keep CPI inflation between 2-3 per cent “on average, over the cycle”. The new statement says 2-3 per cent “over time” – a potentially looser goal that takes into account the current low inflation environment.

The RBA meets this goal by adjusting the official cash rate. The cash rate, announced 11 times a year, is where most people will probably have heard of the RBA.

As Governor, Dr Lowe will chair the monthly meeting that sets this rate. Sitting with him will be banking experts as well as academics and members of industry. For example, his board includes former Origin Energy director John Akehurst and former AustralianSuper chair Heather Ridout.

Importantly, the ‘rate’ that Governor Lowe will set – which affects how much interest we pay on mortgages, business loans and credit cards – is itself a target.

The RBA meets the cash rate target by adjusting its daily auction of loans to the banks. These loans, usually for the term of a month or two, are used by the banks to settle payments between themselves, and between themselves and the RBA.

The inflation target, enforced by the cash rate target, is crucial because it preserves the value of our money. Without it, we risk high inflation, which erodes the savings of retirees, freezes up lending, and triggers an upward spiral of more and more inflation as workers demand higher wages to keep up.

2. Print plastic money

The RBA recently redesigned the $5 note. Photo: AAP
The RBA recently redesigned the $5 note. Photo: AAP

The RBA is responsible for designing, printing, issuing, circulating and destroying Australian bank notes, but has no control over coins.

The RBA was the first currency issuer in the world to issue plastic notes. This has since caught on, with England the latest to issue a plastic £5 note.

The fact that the RBA’s notes are made of plastic and embedded with security features makes them very difficult to counterfeit and much more durable than paper notes.

There were about 1.3 billion Australian bank notes worth about $61 billion in circulation in 2015, according to the RBA.

Coins are the responsibility of the Royal Australian Mint in Canberra.

3. Oversee the payments system

The counterview is that Photo: Getty
The RBA ensures that customers of different banks can pay each other. Photo: Getty

The RBA is also responsible for administering the computer system that banks use to transfer non-cash payments between themselves. Approximately $180 billion goes through this system every day, the RBA estimated in 2014.

When a digital payment occurs between a buyer and seller who are customers of different banks, money needs to flow between the banks to make the payment successful. That’s where the RBA comes in.

High value payments, such as those between banks, are processed in real time. Direct debits and credits by businesses (such as when your electricity provider automatically deducts payment from your account) are usually processed at the end of the same business day. And retail payments, like when you buy a coffee with your credit card, are usually processed at 9am the next business day.

The RBA is currently working on a new system that will allow real-time payments within seconds for everyone.

The bank also regulates the payments system. An example of the RBA functioning in this role is its recent crackdown on excessive credit card surcharges.

4. Act like a regular bank

The OECD is one of the banking customers of the RBA. Photo: AAP
The OECD is one of the banking customers of the RBA. Photo: AAP

The RBA is also the government’s banker.

For example, if you were lucky enough to receive a tax refund this financial year, that money was transferred from the Tax Office’s bank account at the RBA to your bank account.

The RBA also provides banking services to overseas international organisations like the Organization for Economic Cooperation and Development (OECD).

And it acts as a banker to other central banks. The interconnectedness of this system was illustrated in February when a branch of the US Federal Reserve Bank came very close to processing a fraudulent request to transfer $US81 million it was holding on behalf of the Bangladesh central bank.

5. Promote financial stability

The RBA assisted in the global fightback against the financial crisis of 2007-08-09.
The RBA assisted in the global fightback against the financial crisis of 2007-08-09. Photo: Getty

The RBA works with the Australian Prudential Regulation Authority (APRA) and other regulators to promote Australia’s financial stability.

For example, it warns the general public of economic risks through speeches, advises the government and regulators on how to protect against these risks, and works with international organisations on the setting of global rules, such as Basel III.

This is an area of expertise of Governor Lowe, who authored research on the stability function of central banks while seconded to the Bank for International Settlements (the central bank of central banks) in 2000-02.

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