Simran Kaur is co-founder of Girls that Invest, which offers commentary on personal investment aimed at young people.
OPINION: You have probably heard that the Reserve Bank lifted the official cash rate to 1.5 per cent this week.
But what does it really mean?
What is the Reserve Bank and how do I set up an account?
To understand what the Reserve Bank is, you need to understand why it even exists.
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It is the source of command in our banking system. Big banks that everyday Kiwis use sometimes need to access cash through their bank, the bank’s bank if you will.
This is called the Reserve Bank. It also sets some of the rules for the banking sector.
Imagine your everyday bank selling shirts. It would determine the price of the shirts based on what the wholesalers sell them for.
If the wholesaler said the shirts were now $10 wholesale, the banks would charge more than $10 by adding their own margin so they make a profit, too.
In the same way, the Reserve Bank can be seen as a wholesaler of money for the banks we interact with.
Stuff
Simran Kaur says the Reserve Bank is trying to get inflation under control.
What does the OCR do, then?
The OCR isn’t a new concept, it was introduced in 1999. Its main job is to affect how Kiwis are borrowing money.
One of the Reserve Bank’s jobs is to keep inflation within a target range of 1 per cent and 3 per cent over the medium term.
And if you’ve kept up with the news you’ll have seen that inflation is spiking up higher than we’ve seen in both New Zealand but also around the world in decades.
If inflation is a mole rat in one of those “mole in a hole” games, the Reserve Bank is the player, and it’s trying to squash high levels of inflation however it can.
What’s its weapon of choice? Interest rates. By hitting inflation with the “interest-rate-hammer”, the Reserve Bank is able to keep inflation at bay whenever it rears its ugly head.
The official cash rate (OCR) is the rate at which banks can borrow, short-term from the Reserve Bank. When it goes up, it increases what they need to charge customers to remain profitable. When it falls, banks can offer cheaper loans.
Does it affect the economy?
When the economy overheats, an increase in the OCR pushes up interest rates. This discourages borrowing (both from households and businesses) and this helps to cool inflation. The Reserve Bank basically increases the OCR to encourage Kiwis to save more than spend.
The OCR can also help a cool economy to rise up again, by decreasing interest rates and encouraging borrowing as “debt becomes cheap”. We saw this in 2020 and 2021.
Supplied/Stuff
The Reserve Bank lifted the official cash rate to 1.5 per cent this week. Pictured is Reserve Bank Governor Adrian Orr.
How is this going to affect my day-to-day?
Well for one, since borrowing is being discouraged, interest rates are higher. This is good news for the banks who can now charge you 4.5 per cent for a mortgage that was 2.5 per cent this time last year (can you tell I just refinanced my mortgage?).
In the short term, it’s going to be tough because borrowing money hasn’t been this hard in recent years – but inflation doesn’t slither away overnight, so cost increases of goods and services are still quite rampant. It’s hard to spend money and now it’s going to become harder to borrow money, along with a slump in the economy due to lower spending.
The silver lining is that eventually, this OCR change will help bring down inflation. The supercharged price rises should stop when the Reserve Bank is able to keep the peace in our economy and eventually in our pockets.
