What does the Reserve Bank really do?
- Financial Planning
Most of us are aware of how the Reserve Bank play a major role in the economy through their influence on interest rates, but how much do we know about all the other roles they perform? As it turns out, they have many ‘behind the scenes’ functions we rarely hear about, but have a major impact on the stability and oversight of our economy. Let’s take a deeper look into what they do.
The most prominent role of the Reserve Bank is to manage the stability of the currency and the economy through the management of monetary policy via setting of interest rates. Every month the Bank determines the ‘cash rate’ - the interest rate that banks pay to borrow funds on the money market. A lower cash rate allows banks to borrow funds at a more cheaply, which in turn affects the interest rates that they charge to consumers and businesses on borrowings (although they may not always choose to pass on the rate reduction in full, much to the irritation of the government and customers)!
The primary marker they use in setting the cash rate is the consumer price index, which indicates the level of inflation in the economy. By lowering interest rates the Reserve Bank can stimulate demand and spending, which tends to increase inflation. Conversely, increasing interest rates will dampen demand and will tend to lower inflation. To maintain the health and growth of the economy, the Bank considers an inflation rate of 2% to 3% as being the ideal level and will generally adjust interest rates to keep inflation within that range.
The Reserve Bank has over 200 million electronic payments every year
(Image © Reserve Bank of Australia)
Interest rates also have an impact on other prices within the economy, such as the exchange rate, so the Bank must also keep an eye on other aspects of the economy when making adjustments to the cash rate.
The Government’s banker
If you have ever received a cheque from the tax office, social security payment or Medicare refund, did you know that those funds have been managed and paid through the Reserve Bank? They run the Government’s payment system and in doing so, many billions of dollars pass through their hands via over 200 million electronic payments every year. The reliability and security of this system is an important responsibility that directly affects our daily lives.
At a broader level, the Bank has an oversight and regulation role on the payments that occur between banks, such as retail payments and ATM transactions. Their mandate is to help improve competition, transparency and efficiency of the country’s payment system.
Foreign exchange reserves and international operations
As part of its role in ensuring stability of the economy, the Reserve Bank is the custodian of Australia’s foreign exchange reserves. They hold about $40 billion in a range of major currencies offshore on behalf of the nation, with about half of that being in US dollars. This is an important backstop to help protect us in the event of a crisis, where access to foreign funds is essential to maintaining liquidity.
The Bank also manages the government’s day to day foreign exchange transactions, which ensures the smooth operation of Government business, as well as giving the Bank an ‘on the ground’ understanding of what is happening in markets around the globe. This in turn informs other decisions the Bank makes in helping manage the economy.
The dollars we carry around in our wallets and purses all began their lives at the Reserve Bank. They control all of the printing, issuing, circulation and ultimately the destruction of bank notes, so that Australians can have confidence in the currency as a fundamental store of value.
Have you seen the new generation $5 note? (Image © Reserve Bank of Australia)
There is about $61 billion dollars in bank notes in circulation within the system. The centralised control of currency printing ensures that the system is more secure and is protected from counterfeiting, through the stringent design and production controls that the Bank implements.
Maintaining financial stability
The responsibility for maintaining financial stability is an important role, not only for the institutions involved in the financial sector, but also for the social and economic wellbeing of the nation. The Bank plays a major role in fostering stability through its ability to interact and advise financial institutions, the government and regulators on risks, rules and policies.
While they don’t have a direct responsibility for regulating financial institutions, they are a vital source of expertise which, when coupled with their insight into the economy, markets and financial system, allows them to offer high quality advice to the regulators, government and institutions on how risks and weaknesses in the system can be minimised and managed.
The Bank also has a responsibility in crisis situations, such as the 2008 financial crisis. A key aspect of this role is the ability of the Bank to provide certainty to financial institutions that may need to liquidate assets at short notice. Rather than being forced to sell assets at a discount on the open market, institutions can rely on the Bank to purchase assets at a fair price and thereby provide liquidity to maintain stable operations.
Vital for the Australian economy
The strength and expertise of the Reserve Bank is a vital cog in the success of our economy. Unlike many other central banks, our Reserve Bank is governed by a board that draws its members from a variety of backgrounds, including academia, business and other sectors of society. This ensures that the Bank’s operation is based on a solid foundation of broad experience and keeps the wellbeing of all Australians at heart.
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