Tomorrow we'll get the latest figures on inflation in Australia. That data will be critical in helping the Reserve Bank of Australia decide whether to lift interest rates again next month.
Author
- John Hawkins
Senior lecturer, Canberra School of Government, University of Canberra
Answering questions at a lunchtime speech today, RBA Governor Michele Bullock noted "inflation is still too high".
Yet many Australians are confused about how monetary policy - the RBA's setting of interest rates - actually works, according to a new RBA survey .
This surprising finding means the central bank has more work to do in explaining why it has raised interest rates three times this year, and may hike them again on August 11 or later this year.
Only 25% of respondents in the survey correctly answered that higher interest rates would lower inflation . There were other misconceptions, as well, including a belief by a significant minority that the RBA sets tax rates. (Spoiler: that is the government's job.)
So let's unpack how interest rates actually work. And at the end of the article, you can take the RBA's quiz and see how well you understand the economy.
Inflation is the top concern
The RBA survey of 9,000 Australians over 2025 and 2026 found that inflation was by far the biggest economic concern.
About two-thirds of people ranked it among their top three concerns. Inflation was the top economic concern across all demographic groups, but it was highest among lower income households.
The survey found "respondents who cited inflation as one of their top concerns were more likely to expect both economic conditions and their household financial situation to worsen over the next 12 months".
The majority of Australians correctly believe the RBA is concerned about inflation. But only around a quarter are aware it also has an objective of full employment.
Probably most concerning for the RBA were the responses to questions about the impact of higher interest rates. Only a quarter of people correctly replied that higher interest rates would reduce inflation. More than half thought higher interest rates would increase it. The others were unsure.
This is how interest rates actually work
The survey suggests many Australians believe higher interest rates are not just a painful cure for inflation - but actually worsen the disease. It suggests inflationary expectations could continue to rise, the opposite of what the RBA is trying to achieve.
A similar study in the United States suggested many people believe companies will pass on higher interest rates to consumers by pushing up prices.
By contrast, economists regard higher interest rates as dampening demand for goods and services, which leads to lower inflation.
"We need to do a better job of getting out there and explaining to people in simple terms what is going on (in the economy)," Bullock said on Tuesday.
There are a number of ways higher interest rates dampen demand.
The most discussed is that higher mortgage interest rates leave the one-third of households with a mortgage with less money to spend on other things.
But this is only one channel. Higher interest rates also make saving more attractive, which reduces spending.
Higher borrowing costs flow through to all forms of debt. It makes borrowing by consumers to buy cars, furniture and whitegoods less attractive, deferring spending on these items. Companies facing higher borrowing costs may undertake fewer investment projects.
Higher interest rates tend to lower the value of assets such as shares and houses. This makes households feel less wealthy and less likely to spend.
Higher interest rates can also push up the value of the Australian dollar. A stronger dollar makes imports less expensive for Australian consumers, directly lowering prices and also tending to reduce domestic production of goods that compete with imports.
High levels of trust
The RBA survey has some good news for the bank.
Majorities of people surveyed (correctly in my view) believe the RBA "makes decisions based on facts", "acts with integrity" and is "open and honest". The prime minister, treasurer - and indeed most politicians - would envy approval ratings like that.
More than 70% of people correctly identified that the RBA sets the cash rate (its policy interest rate). And around 40% also knew about its responsibility for producing and distributing banknotes and overseeing the payments system.
But a significant number held the RBA responsible for things they no longer do. For instance, almost 60% thought the central bank regulates banks. The RBA used to do this, but since the 1990s it has been the responsibility of the Australian Prudential Regulation Authority .
About half the people surveyed thought the RBA controls the exchange rate. This was once the case, but since the Australian dollar was floated in 1983, its value has been set by market forces.
About a third of people even believed the RBA is responsible for setting tax rates, over which it has absolutely no influence. That's the government's job.
And about a third believed it provides banking services to households, which has not been the case since it was separated from the Commonwealth Bank in 1960.
Perhaps the RBA needs to find catchier ways of getting its message to the people, as the Bank of Jamaica has done with its award-winning video .
Test your economic knowledge
John Hawkins was formerly a senior economist at the Reserve Bank.
