Question about reserve bank

This isn't a question so much about shares but its a very beginner question so I will ask in here.

I understand that its a very complex system and there are surely whole books on the subject but I wouldn't mind a quick dumb downed version so when I do start reading some literature I wont be overwhelmed.

From what I understand the reserve banks goal is to try and keep inflation around the 2-3% mark to try and keep a healthy economy.

They do this by increasing or decreasing the interest rates because high rates means less borrowing and more saving for people and vice versa.

So if the economy is slowing down, rates are dropped and people take out loans and spend cash to stimulate the economy.

But where do the inflation figures come from? is it from the XJO? if the XJO was flat lining and there was no real growth would this indicate no inflation where if the XJO was increasing rapidly would this indicate high inflation?

Hi Paul. Inflation is measured by the Consumer Price Index (CPI). Have a read of this site http://www.abs.gov.au/ausstats/abs@.nsf/mf/6401.0 for more info.

Thank you, but this leads me to my second question.

Does the CPI and interest rates have an effect on the index?

eg. In 1990 when interest rates hit 17% for home loans what was happening with the stock market?

And could you get amazing rates for cash accounts? (15% or something like that?)

All asset markets, including shares and bank deposits typically compete for capital (money). So in theory, high interest rates should encourage money to flow from the stock market (hence lowering the XJO as share prices fall) into savings accounts take advantage of high rates on savings deposits. And vice versa, low interest rates would encourage funds to move out of bank deposits into the share market (hence increasing the XJO as share prices rise) as investors chase higher returns.

This is the theory, but I have no idea what the actual correlation figures look like. Would be good if someone could enlighted us.

The relationship between the CPI and XJO is far more complex. CPI, as it measures prices of a "basket of goods and services" can be thought of as almost another asset class which competes for money. Ie you have $1000, you can put it in a bank deposit, a stock, or you can spend it on goods and services. Whichever way you choose to use the money, it will add to prices in that asset class. So you can look at the CPI/XJO relationship as being two asset classes competing for funds. However, there is also the indirect relationship that occurs because CPI and interest rates are correlated, as are interest rates and share markets. As I said, far more complex.

Somebody here may have better ideas than me however.

Paul24 said:

And could you get amazing rates for cash accounts? (15% or something like that?)

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You certainly could get rates like that at that time.

There was no such thing as what we now know as "online" high interest accounts back then (nobody had the internet at home...) but term deposits were reasonably popular at the time and paid those sort of rates.

At-call cash accounts also paid high rates compared to those available today. Generally speaking, you'd get a better rate with an "investment" account having no electronic access whatsoever (no ATM card) 20 years ago but even everyday accounts paid decent interest.

Worth noting also that the idea of switching banks to get a better rate on a loan was not at all common 20 years ago since actually getting a loan was considerably more difficult, and assed partly on your historic relationship with the bank. A New customer with no savings record with the same bank was unlikely to be approved for a loan. Fixed rate home loans weren't common either.

Credit card interest rates are one thing that hasn't changed a lot. As general interest rates came down, credit card rates were reduced by a far lesser amount.