RBA Interest Rate: Who Really Pays for Inflation?

By Denis Hay  

Description

Why RBA interest rate rises punish ordinary Australians – and what the federal government could do instead to control inflation.

Australia has been told a familiar story: inflation is too high, so interest rates must rise. Households must spend less. Workers must moderate wage demands. Some people may lose their jobs, but this is presented as the unavoidable price of restoring economic stability.

But that explanation conceals a profound question of fairness:

Who is being asked to pay for inflation – and did they cause it?

The Reserve Bank of Australia’s cash-rate target is currently 4.35 per cent. In the 12 months to May 2026, the Consumer Price Index rose 4.0 per cent, while underlying inflation measured by the trimmed mean was 3.6 per cent. The largest annual price increase was housing, at 6.5 per cent, followed by food and transport, both at 3.3 per cent.

These are not luxuries that families can simply stop buying. People need somewhere to live. They need food, electricity, transport and healthcare. Yet our main response to rising essential costs is to make mortgages, business finance and new housing construction more expensive.

That is not a neutral economic adjustment. It is a political choice about who carries the burden.

What Do Higher Interest Rates Actually Do

The RBA does not directly reduce supermarket prices, build homes, produce electricity or increase the supply of fuel. It changes the cash rate, which influences borrowing and saving rates throughout the economy.

Higher rates are intended to reduce demand by:

• increasing mortgage and loan repayments;
• discouraging households and businesses from borrowing;
• encouraging saving rather than spending;
• slowing investment and economic activity; and
• weakening employment and wage growth.

The RBA itself explains that monetary policy works by influencing aggregate demand, employment and inflation. In plain language, it attempts to restrain prices by leaving households and businesses with less money to spend.

That approach may help when inflation is mainly caused by excessive economy-wide demand. But it is far less effective when prices are rising because of shortages, supply disruptions, inadequate housing, energy costs, market concentration or international conflict.

Even the RBA recognises this distinction. It has previously explained that central banks may “look through” temporary supply shocks when inflation expectations remain contained. Interest rates cannot manufacture fuel, repair supply chains or construct affordable homes.

The Burden Is Deeply Unequal

A rise in the cash rate does not affect everyone equally.

Mortgage holders pay first

Households with large variable-rate mortgages can lose hundreds of dollars a month from their disposable income. Younger buyers and families who entered the housing market at inflated prices are especially exposed.

Meanwhile, people who own their homes outright face no mortgage increase. Those holding substantial interest-bearing deposits may receive more income.

The result is a major transfer within the community. The policy takes spending power from heavily indebted households while rewarding some wealthier savers.

The Australian Bureau of Statistics’ Selected Living Cost Indexes show why the headline CPI does not tell the whole story. Mortgage interest charges are excluded from the CPI but included in the living-cost measure for employee households. In the March 2026 quarter, employee households experienced a 1.4 per cent rise in living costs, with mortgage interest charges among the important contributors.

For many working households, the treatment prescribed for inflation becomes another source of their rising cost of living.

Renters do not escape

Renters may not receive a letter from their bank, but they can still bear the cost. Landlords may attempt to recover higher financing costs through rents where tight markets allow it. Higher interest rates can also discourage residential construction, worsening shortages over time.

Australia therefore risks using a housing-cost increase to fight inflation in which housing is already the largest contributor.

Small businesses are squeezed

Small businesses often depend on overdrafts, equipment finance and commercial loans. Higher interest costs can force them to postpone investment, reduce staff hours, lift prices or close.

Large corporations generally have more financing options and bargaining power. Once again, the burden falls most heavily on those with the least capacity to absorb it.

Workers may pay with their jobs

The most troubling part of conventional inflation policy is often left unstated. Higher rates are designed partly to slow employment and wage growth.

Workers who did not cause international oil shocks, housing shortages or concentrated supermarket markets may be expected to accept weaker bargaining power – or unemployment – to stabilise prices.

Wages grew 3.3 per cent over the year to the March 2026 quarter. That was below May’s annual CPI increase of 4.0 per cent. It is difficult to argue that ordinary workers are enjoying an uncontrolled wage boom when prices are rising faster than their pay.

Interest Rates Cannot Solve Every Kind of Inflation

Inflation is not one single disease. It can have several causes, and each requires a different response.

Demand-driven inflation occurs when total spending persistently exceeds the economy’s capacity to supply goods and services. In that situation, restraining demand may be necessary.

Supply-driven inflation is different. It can result from:

• war and international fuel-price shocks;
• droughts, floods and crop failures;
• disrupted supply chains;
• shortages of skilled workers or materials;
• inadequate housing, energy or transport infrastructure;
• monopoly power and weak competition; or
• privatised essential services charging excessive prices.

Suppressing household demand does not remove these bottlenecks. In some cases, higher interest rates can worsen them by discouraging the investment needed to expand productive capacity.

This does not mean interest rates never matter. Nor does it mean inflation should be ignored. Persistent inflation harms people on low and fixed incomes and can destabilise the economy.

It means Australia should stop treating one blunt instrument as the entire toolbox.

The Missing Role of the Federal Government

Public debate often gives the impression that the RBA must fight inflation alone because the federal government has few options.

That is untrue.

The Australian Government is the issuer of the Australian dollar. Unlike a household, business, state government or local council, it cannot involuntarily run out of Australian dollars. It can always make payments authorised by Parliament in its own currency.

But monetary sovereignty is not a licence to spend without limit.

The real constraints are the workers, skills, machinery, energy, materials and productive capacity available for purchase. If governments spend beyond the economy’s ability to produce, they can cause inflation. Currency sovereignty means the central question is not simply, “Where will the money come from?” It is:

Do we have the real resources, and how can they be mobilised without driving up prices?

That understanding expands the choices available to government while imposing a more meaningful discipline than arbitrary claims that Australia has “run out of money.”

A Fairer Anti-Inflation Strategy

Australia needs a coordinated strategy that tackles the source of price rises and distributes necessary restraint according to capacity to pay.

1. Build public and affordable housing at scale

Housing inflation cannot be solved only by making mortgages dearer. The federal government should fund a long-term public housing program, delivered with states, councils, community housing providers and public construction capacity.

This must be carefully staged around available labour and materials. Training apprentices, expanding TAFE, supporting prefabricated construction and rebuilding public-sector expertise would increase capacity rather than merely bidding up prices.

Public housing would not only help people in need. By providing a substantial non-market alternative, it could place competitive pressure on private rents and improve stability throughout the housing system.

2. Reduce essential energy costs

Australia is rich in energy resources, yet households remain exposed to high electricity and gas prices.

The government can invest directly in renewable generation, storage, transmission and household efficiency. Public ownership or stronger public participation would allow essential energy policy to be guided by affordability, reliability and emissions reduction – not only private returns.

Unlike temporary rebates, investment that lowers the cost of producing and delivering energy expands capacity and can reduce inflationary pressure over time.

3. Strengthen competition and price transparency

The Australian Competition and Consumer Commission has recommended reforms to improve supermarket price transparency and supplier treatment. New excessive-pricing rules applying to very large supermarkets commenced on 1 July 2026.

These measures should be rigorously enforced. Where essential markets are dominated by a handful of corporations, government must be willing to use competition law, price monitoring, public alternatives and, where justified, stronger regulation.

Interest rates should not be used as a substitute for confronting market power.

4. Use targeted taxation to withdraw excess demand

Tax is not only a way to “raise money.” For a currency-issuing federal government, taxation also creates room for public spending by reducing private purchasing power and can improve fairness by concentrating restraint where it can best be absorbed.

If demand must be reduced, targeted measures affecting excessive profits, economic rents, speculative gains and very high incomes are fairer than forcing a highly indebted nurse, tradesperson or young family to carry the burden through mortgage increases.

Well-designed taxes can also discourage unproductive speculation while leaving ordinary consumption and productive investment less affected.

5. Protect incomes without fuelling scarcity

Pensions, benefits and low wages must not be allowed to fall behind essential living costs. People on the lowest incomes generally have little discretionary spending to cut.

Income support should be combined with measures that expand the supply of housing, healthcare, energy and transport. Supporting purchasing power without addressing shortages can add to price pressure; expanding essential capacity without protecting incomes leaves vulnerable people behind. Australia must do both.

6. Make monetary and fiscal policy work together

RBA independence should not mean that elected governments abandon responsibility for inflation, employment and distribution.

The Bank should explain who bears the cost of its decisions, not only the predicted effect on aggregate inflation. Governments should present an explicit inflation strategy showing which price pressures are demand-driven, which are supply-driven and which policy is being used for each.

Democratic accountability requires more than announcing that difficult decisions are someone else’s responsibility.

What About the Common Objections?

“Government spending always causes inflation”

Government spending can be inflationary when it pushes total demand beyond productive capacity. But spending that expands capacity – such as well-planned investment in energy, skills, transport and housing—can reduce costs and inflationary pressure over time.

The effect depends on what is purchased, when it is purchased, whether unused capacity exists and what taxes or regulations accompany the spending.

“Higher rates are painful but necessary”

Sometimes monetary restraint may be justified. The real issue is whether the size and distribution of that restraint fit the cause of inflation.

A policy can reduce demand and still be unnecessarily unfair. Before imposing further pain, decision-makers should demonstrate why more targeted alternatives would be insufficient.

“Savers deserve a reasonable return”

Savers matter, particularly retirees who depend on interest income. But their needs should not be met indirectly by placing severe pressure on mortgage holders and employment.

Retirement security is better protected through adequate universal pensions, fair superannuation arrangements and stable public services than through an economy dependent on high interest rates.

Inflation Control Is About Values

Economic policy is often presented as if it were a mechanical process beyond democratic choice. It is not.

Every inflation strategy decides:

• whose spending will be reduced;
• whose income will be protected;
• which investments will proceed;
• whether unemployment is treated as a policy tool;
• whether essential services remain subject to profit-driven pricing; and
• whether the costs fall on those most able – or least able – to pay.

Australia can control inflation without pretending that mortgage stress, rent increases, business failures and unemployment are unavoidable acts of nature.

The federal government has the monetary capacity to act, but it must use that capacity responsibly, matching spending to real resources, expanding productive capacity and withdrawing excess demand where necessary.

The choice is not between fighting inflation and pursuing social justice.

A fairer economy requires us to fight inflation intelligently: at its source, with the right tools, and without sacrificing the people who did not cause it.

Frequently Asked Questions

Why does the RBA raise interest rates?

The RBA raises the cash rate to reduce borrowing and spending, slow aggregate demand and return inflation towards its 2–3 per cent target. The policy also affects employment, investment, asset prices and the exchange rate.

Do higher interest rates reduce all inflation?

No. They can reduce demand-driven inflation, but they cannot directly increase the supply of housing, food, fuel or energy. Their effectiveness depends on what is causing prices to rise.

Are mortgage interest payments included in the CPI?

Mortgage interest charges are not included in Australia’s CPI. They are included in the ABS Selected Living Cost Indexes, which are designed to measure changes in households’ out-of-pocket living expenses.

Can the Australian Government run out of Australian dollars?

The federal government issues the Australian dollar and cannot involuntarily run out of its own currency. Its spending is constrained by legislation, political decisions and – most importantly – the real productive capacity of the economy. Excessive spending relative to available resources can cause inflation.

What could government do instead of relying only on rate rises?

It could combine carefully targeted demand restraint with public housing, energy investment, competition reform, workforce training, stronger essential-service regulation and fair taxation. Interest rates may remain one tool, but they should not be the only one.

Sources

1. Reserve Bank of Australia – Monetary Policy Decision, 16 June 2026
2. Reserve Bank of Australia – The Transmission of Monetary Policy
3. Reserve Bank of Australia – Monetary Policy, Demand and Supply
4. Australian Bureau of Statistics – Consumer Price Index, May 2026
5. Australian Bureau of Statistics – Selected Living Cost Indexes, March 2026
6. Australian Bureau of Statistics – Wage Price Index, March 2026
7. Australian Competition and Consumer Commission – Supermarket reforms
8. Australian Competition and Consumer Commission – Excessive pricing rules

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