What monetary policy is
The Reserve Bank of Australia is responsible for monetary policy. Its conventional tool is the cash rate target, the interest rate around which overnight lending between financial institutions takes place. Changes in the cash rate influence other interest rates in the economy, including many lending and deposit rates faced by households and businesses.
The RBA's monetary policy framework aims to support price stability and full employment, with inflation targeted at 2 to 3 per cent over time. The effect of a rate decision is not immediate or mechanical; it works through financial conditions, spending, saving, investment, the exchange rate and expectations.
Why higher rates can reduce inflation
Higher interest rates increase borrowing costs for many households and businesses and can make saving more attractive. That tends to reduce demand relative to what it otherwise would have been. Weaker demand can ease pressure on prices over time, although the strength and timing of the effect depend on economic conditions.
Lower rates generally work in the opposite direction by supporting borrowing and spending. Monetary policy therefore involves trade-offs, especially when inflation is too high but growth or employment is weakening.
The cash rate is not every interest rate
Banks do not simply copy the cash rate into every product. Mortgage, business, credit and deposit rates are also influenced by funding costs, competition, risk, product design and financial-market conditions. The cash rate is a powerful benchmark, not a universal price set directly by the RBA.
That is why a change in the cash rate can be passed through differently across lenders and products.
Monetary policy versus fiscal policy
Monetary policy is set by the RBA through its monetary policy framework. Fiscal policy refers to government decisions about taxation, spending and borrowing, principally expressed through budgets and legislation. Both can influence overall demand and inflation, but they are made by different institutions using different tools.
Political debate sometimes treats the RBA and the government as if they control the same levers. They do not. Governments can change taxes or spending; the RBA sets monetary policy independently within its statutory framework.
How to read a rate decision
Do not focus only on whether the cash rate moved. Read the RBA's explanation of inflation, employment, economic activity and risks. The reasoning can change even when the rate stays the same, and financial markets often react to the outlook as much as to the decision itself.
For household decisions, use current information from lenders and official sources rather than assuming a particular mortgage change from a headline cash-rate figure.
Primary sources and further reading
We use authoritative Australian institutions as the starting point for this explainer. Follow these links for the underlying rules, official guidance and current details.