Too many people are ignorant about the purpose and function of the Reserve Bank of Australia. In order to remedy this situation - let's start by looking at the relationship between the Australian government and the RBA:

The Australian government handed to the RBA the responsibility of setting the monetary policy of this nation. Monetary policy is the most important policy that any sovereign nation can set - since it affects the economic status of each and every resident. A monetary policy will determine the general level of interest rates in the economy, the quantity of money in circulation, and the price of all goods, services and assets.

The statement from the RBA as given above, would be a lot more accurate if it read:

The Reserve Bank Act 1959 gives the Reserve Bank Board the power to determine Australia's monetary policy and take the necessary action to implement any policy changes.

Is it not strange that as electors and representatives - we are competent enough to debate and set policies on Tax, Defence, Housing etc, but that we have given up our right to draft that one policy that affects us all in our wallet, each and every day of the year.

The role of the RBA

The RBA has set out what its role is - as provided below:

What is "monetary policy"?

What is of interest is the fact that the RBA openly states that their actions affect the price of assets, goods and services in the economy (i.e. they can make prices go up or down). This is an indication of the awesome power held by the RBA. Their own graph displays this clearly.

Mr Costello (in an article referenced below) calls the RBA the "biggest price signaller". In blunt terms - the RBA attempts to "fix" the price of money in the market. In any other industry, this would result in calls to investigate "price fixing", with all the legal consequences.

Who owns the RBA?

This is a common question regarding the RBA. The RBA web site gives no indication, and an internet search is equally frustrating. A statement regarding ownership was made by Peter Costello in The Age of 24th November 2010.

The ASP assumes that when Mr Costello refers to the owner of the RBA being "the government" - he means the Commonwealth. Until such time as the ASP can examine a share register to verify otherwise, we will tentatively assume that the RBA is indeed owned by the Commonwealth.

Does the RBA lend money to the government?

In a nutshell - NO. The RBA does not lend money to the government on a regular basis. The government normally borrows from commercial banks and other private sector organisations. However, the RBA does provide an "overdraft" facility for the odd occasion when the government has cash mismatches (i.e. it runs out of cash for short periods of time).

Is the RBA a banker to the government?

In this case - YES. Effectively the RBA manages the bank account of the government. However, as stated above, the RBA does not lend to the government.

RBA - Conducting Monetary Policy

Monetary Policy is implemented at the RBA in 2 steps:

1. Each month the RBA sets a "target cash rate".
2. Each day the RBA varies the amount of funds it makes available to banks - in order to get the actual cash rate as close as possible to the target cash rate.

An example of such a monthly announcement is given below.

As mentioned, this rate is only the "target cash rate". The RBA conducts daily "Open Market Operations" where banks bid competitively for funds. By varying the amount of funds available for banks, the RBA can effectively influence the actual cash rate and move it toward the "target cash rate".

In this manner, the RBA effectively controls interest rates in the economy. In blunt terms, the RBA sets interest rates by manipulating the availability of funds to banks.

RBA - Issuing the nation's currency

One of the most flawed beliefs - is that the RBA somehow "creates" all of the money used in the Australian economy. When asked "who creates money", members of the public invariably answer with "the government" - without any supporting reason or experience. To get the correct answer, let's refer to the RBA web site, and read carefully.

Here are a few observations that flow from the statements above:

1. The RBA is responsible for producing and issuing "banknotes", but not coins.
2. The RBA only issues banknotes when they are "ordered" by commercial banks. Banks will pay the RBA for these banknotes at full face-value, i.e. the banks credit the RBA with $100 in order to get a $100 banknote.
3. The Royal Australia Mint is responsible for producing the coins. One can only assume from this that the Royal Australian Mint acts under instruction of the Treasury - and that the government therefore receives the benefit of the Seigniorage.

This mechanism is the same as practiced by the Federal Reserve system in the USA, i.e. the central bank only issues hard cash in return for their own account being credited with electronic money. Consequently - this role of the RBA does NOT create any new money in the economy. The RBA merely delivers banknotes in exchange for electronic money.

Below is a concise explanation of how this process works in the USA.

A Primer on Money: Statement by the Committee on Banking and Currency, House of Representatives, 88th Congress, 5 August 1964, page 44:

When someone goes to the bank and asks for currency – “cash” – in exchange for a cheque, the bank gives him the currency and reduces his chequeing account by the amount of the cheque. Than as the bank needs “cash” itself to meet its depositors’ demands, it gets the cash from the Federal Reserve by having its deposit reduced.

What is the Reserve Requirement figure?

A Reserve Requirements is generally stated as a percentage, and is set by the central bank in order to restrict the ability of banks to lend. A figure of 0% indicates that banks can monetize as much debt as they please, while a figure of 100% indicates that they can only lend out to the value of their deposits.

As can be seen from the Wikipedia entry below - there is no reserve requirement on Australia banks.

RBA - other roles

Three other functions that the RBA performs (and which are very necessary to the economy), are:

• Regulating the financial industry (via APRA), and
• Setting the standards for the payment systems, and
• Setting the standards for the clearing & settlement systems.

Each is referenced briefly - since these functions are fairly straight forward and not contentious.

Attachments:

RBA - Open Market Operations

[An overview of the functioning of the RBA Open Market Operations]

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