HOW THE FEDERAL RESERVE BANK STARTED USING HIGHER INTEREST RATES TO CONTROL INFLATION

resource https://www.rba.gov.au/education/resources/explainers/origins-of-the-reserve-bank-of-australia

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HISTORY OF INFLATION CONTROL –

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1939 to 1945: The Demands of Another War

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1. The Second World War compelled the Australia’s leading Bank again contribute to the raising of loans to fund military activity. With low unemployment and high spending power on one hand, and reduced supply of consumer goods on the other, the risk of uncontrolled inflation grew. The raising of war loans from the public served to mitigate this risk. This was one of the earliest and most direct interventions the Bank had made in attempting to control inflation.

2. The Bank also played a prominent role in wartime economic planning, and it formally took on further central banking responsibilities, such as exchange controls, interest rate controls and the power to compel private banks to lodge funds with it in special accounts. Under this system, the Bank could require that 100 per cent of any increase in bank assets after September 1939 be lodged in its special accounts. Movement of funds into and out of these accounts was closely monitored and regulated by the Bank. However, these were only temporary wartime powers.

 

1945 to 1959: A legislative foundation

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1. With the expiration of these powers at the end of the Second World War, new legislation was passed – the Commonwealth Bank Act 1945 and the Banking Act 1945. It formalised the Bank's powers in relation to the administration of monetary policy, interest rates, banking policy and exchange rate control. This was the first time the Bank had been formally given a legislated responsibility to pursue macroeconomic objectives. Commercial banks were required to lodge significant funds in ‘special accounts’ held by the Commonwealth Bank – the precursors to the deposit accounts that banks have at the Reserve Bank today – to record the value of their Exchange Settlement balances.

2. Further organisational delineation of the Bank's central banking functions took place when the Commonwealth Trading Bank was given a separate legal status in 1953. This left the remaining entity, the Commonwealth Bank, as the nation's central bank. The Commonwealth Bank, the Commonwealth Savings Bank and the Commonwealth Trading Bank shared the same Board of Directors.

 

1959: Separation of the Commonwealth Bank and Reserve Bank of Australia

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1. By the late 1950s, the dual functions of the Commonwealth Bank as both a central bank and a trading and savings bank had become problematic. For some decades, the privately owned commercial banks in Australia had held the view that the Commonwealth Bank's involvement in these two areas simultaneously could give it an unfair advantage over other trading and savings banks operating in Australia. The previous structural reconfigurations did not fully address these criticisms. The government felt that, to maintain public confidence in the nation's central bank, these two functions should be formally separated.

2. The Reserve Bank Act 1959 separated the Commonwealth Bank into two entities – the Reserve Bank of Australia and the Commonwealth Banking Corporation. The Reserve Bank would act as the nation's independent central bank, and the Commonwealth Banking Corporation would continue operating as a trading and savings bank. The Commonwealth Bank was renamed the Reserve Bank of Australia. The old board of the Commonwealth Bank was transferred to the Reserve Bank, and a new Commonwealth Banking Corporation (consisting of the Commonwealth Trading Bank, the Commonwealth Savings Bank and the Commonwealth Development Bank) was created as a new organisation with a new board.

3. When the Reserve Bank commenced operations on 14 January 1960, its legislated objectives were to contribute to:

 

3.1   The stability of the currency of Australia

3.2  The maintenance of full employment in Australia

3.3  The economic prosperity and welfare of the people of Australia.

These remain the Reserve Bank's objectives today, and are often referred to as the Bank's ‘charter

 

The Reserve Bank of Australia commenced operations as Australia's central bank on 14 January 1960. This was the culmination of a long journey towards central banking, which had begun much earlier.

Why Does the Reserve Bank Target Inflation? The Reserve Bank uses an inflation target to help achieve its goals of price stability, full employment, and prosperity and welfare of the Australian people. This is because price stability – which means low and stable inflation – contributes to sustainable economic growth.

As an independent central bank, the Reserve Bank is accountable to the Parliament for its actions. There are requirements in the Reserve Bank Act 1959 for the Bank to consult with the Australian Government.

The government set up the Reserve Bank. The government appoints every member of its board. The government directly appoints its chief and deputy chief. And from time to time the government gives it running instructions

The Reserve Bank is an independent central bank, accountable to the Parliament of Australia. The Bank has two boards: the Reserve Bank Board, which has responsibility for monetary and banking policy; and the Payments System Board, which has responsibility for payments system policy