Interest rate Hikes:Friend or foe? Macroeconomic approach to a Microeconomic problem

Interest rates have been pushed up in recent times, driven by the seemingly tactless monetary authorities whose motivations and agendas are unknown to the general public. Over the past three quarters the cash rate has reached a six year high of 6.25% according to the RBA. This has caused much controversy in both the media and amongst households. According to the Australian Bureau of Statistics, approximately forty percent of homes are either mortgaged or owner occupied (previously subjected to a mortgaged) and as such, bear the brunt of any interest rate hikes in the form of increasing loan repayments. As a result, announcements of interest rate movements are commonly met with strong opposition from the majority of misinformed consumers, many of which are oblivious to the motivations of banking authorities for undertaking these actions. The common misconception is that these rises serve only to unjustly transfer wealth away from households. Consequently, lower interest rates are seen to be favourable as they can facilitate higher levels of investment and economic growth.

Whilst an economy characterized by high growth may seem desirable, closer scrutiny of the larger effects reveals what only those privy to the finer workings of economic policy and its inner workings will understand. Consumers as a whole are motivated by rational self interest on a microeconomic scale, they are more aware of the direct effects of interest rate increases and its effects on their housing payments and other loans without asking the question: “why does the government do it?” Monetary authorities are frequently under attack by angry households that overlook the positive benefits they endeavour to induce.

The growth of our economy (in terms of the demands we place on it) above a reasonable rate does not allow productive efforts to keep up i.e. demands are placed upon the system that cannot be satisfied with currently available resources. This leaves prices as the only remaining factor that can move in response to excessive demand, and as such, they will increase. If prices are too high, average standards of living will decline as agents cannot satisfy the level of purchasing to which the had become accustomed. Even the most ill informed consumer will recognise this as inflation and be averse to the aforementioned consequences.

However, inflation in itself is not a bad thing. Stable and controlled price rises (targeted at 2-3% in Australia) lead to a healthy economy, characterised by optimism regarding future investment patterns and returns, the result of which is the aforementioned economic growth but in a much more controlled fashion. To prevent excessive inflation, monetary authorities attempt to raise interest rates in an effort to stem excessive demand growth. As such there becomes a trade off between keeping inflation low and raising interest rates.

More attention is paid in the media and amongst the average consumer to the “dark cloud” stigma that surrounds interest rate hikes. Many dinner table conversations revolve around opinionated bashing of monetary authorities for their “ruthless” increases in interest rates on the poor and neglected masses. Many individuals are aware only of the immediate effects these rises have on them, but fail to acknowledge the effects that are avoided by ensuring inflation and excessive growth are controlled. A strong economy is one that not only expands, but does so in a fashion that is sustainable and enables future prosperity and stability.