The brutal redistribution at the heart of the RBA's interest rate policy
RBA officials argue the hit to borrowers' income isn't the main way rate rises lower inflation. But they often omit a key fact.
The Reserve Bank of Australia (RBA) has been trying to convince Australians that interest rate policy doesn't primarily hurt borrowers through the "cash flow channel." Economists explain that rising interest rates reduce the cash households have available for spending. With less spending, demand for goods and services decreases, which should control inflation.
This channel is the most visible impact for those with mortgages and the most painful for them. However, the RBA downplays the importance of this channel, focusing more on the public discussion.
What the RBA officials often overlook is that the cash flow channel is a two-sided coin. While borrowers face higher interest payments, savers receive significantly higher returns on their deposits. For instance, for every extra dollar households pay in interest on their mortgages, they receive about 72 cents more in interest income.
This balance reduces the overall impact of the cash flow channel on consumer demand. Moreover, there's another transmission mechanism called the intertemporal substitution channel, where higher interest rates encourage people to save more or borrow less. This is supported by APRA banking data showing a 25% increase in outstanding household debt and a 37% rise in household deposits between 2022 and 2026.
A decade-old RBA staff research paper found that borrowers' spending is at least twice as sensitive to changes in interest-sensitive cash flows compared to lenders. This is because many borrowers are living at or near their financial limits, making them more vulnerable to higher rates. However, the extra income from savings blunts the overall cash flow effect, meaning borrowers must endure higher rates to offset it.
The RBA's research also highlighted that older savers, particularly those over 65, have benefited more from rising rates, while middle-aged borrowers aged 30-54 have lost out. Middle-aged households, many with families and expenses, are feeling the pinch the most. Those with financial buffers built during the COVID low-rate period are less affected by rate increases.
Consequently, younger, recent homeowners with the biggest mortgages, smallest financial buffers, and families are the ones bearing the brunt of the cash flow channel of monetary policy.
Written by urgent.news from ABC News AU's reporting — not their text. Machine-written — may contain errors; check the original before relying on it.
