The Reserve Bank has delivered its fourth rate hike for 2026, bringing interest rates to the highest level since November 2011.

Meanwhile, the Australian share market opened higher in morning trading ahead of the RBA's interest rate decision.

US bonds surged as Wall Street closed lower.

Meanwhile, oil is trading above $US105 a barrel.

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https://www.abc.net.au/news/2026-09-29/asx-markets-business-news-live-updates-tuesday-29-september/107206212

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Crispin Hull

Rate rises hit mortgage holders, first-home buyers and jobs, while doing nothing to fix many of the supply shocks driving prices higher. Governments need to carry more of the burden through taxation and responsible budgets.

I had an economics teacher who once joked that he set the same exam questions year after year. It was not a problem, he said, “Because I just change the answers.”

There is a lot of truth in that. The rise of behavioural economics in the 1990s, for example, put paid to the stupid presumption in economics that people behave rationally.

And in the 1990s, if you asked the question: “What can a central bank do to curb inflation?” The answer would have been: “Increase interest rates.” In the 2020s, however, when central banks have applied that formula, they leave themselves open to the charge of destroying the economy in order to save it from inflation.

A better answer might be for central banks to plead that they only have one weapon – interest rates – and that weapon might not be effective enough to deal with the political and economic difficulties ahead. However, if you only have one weapon, that is what you must use. It is a bit like a householder with only a frying pan to deal with a mice plague. Beating a few mice over the head with it is not going to stop the plague.

A better answer to the question might be to plead with governments to get their budgets in order so they are not pumping money into the economy and driving up demand and therefore prices, and also so that they are not adding to the demand for capital and therefore its price (interest).

Another part of the answer would be to question the relationship between interest rates and inflation and whether the cure is worse than the disease.

Fundamentally, a core task of government is to provide a stable currency. Without a stable currency, trust in the system breaks down. An extreme example was in 1920s Germany when hyper-inflation caused the collapse of the Weimar Republic and the rise of Hitler.

It is no accident that the rise in the popularity of One Nation in Australia has coincided with a sharp increase in inflation. One Nation supporters blame the government for all ills and turn to political parties with simplistic solutions which are no solutions at all.

Populists like US President Donald Trump always call for low interest rates, irrespective of economic reality. “Interest Rates in the United States should be 1%, or less, because we are the Best Credit in the World — BY FAR,” he said.

Trump’s mistake is that he puts all the emphasis on the risk of non-repayment in assessing what interest rates should be. It is understandable. He knows all about people defaulting on debt.

However, he does not take into account the likelihood, verging on certainty, that there will be partial non-repayment when the debt falls due, because by then inflation would have eroded the value of the capital being repaid. That is why people lending money demand higher interest rates – to cover the erosion of value caused by inflation.

If inflation gets too high, people will stop lending money or demand prohibitive interest rates. If people cannot borrow money they cannot start up or sustain businesses, causing more people to be thrown out of work.

In the US, the Federal Reserve defied Trump’s facile analysis and raised interest rates. The Fed saw that Trump’s massive tax breaks for the wealthy were boosting demand and causing high prices. The lost revenue also meant that the government had to borrow more, putting pressure on the price of capital (interest). Without those tax breaks, higher interest rates might not have been needed.

In the US, it was the old story: the rich get tax cuts and the less wealthy pay with higher interest rates. And Trump is the author of that.

Australia’s Reserve Bank has similar difficulties. Faced with a rising Consumer Price Index, it increased interest rates in May 2022 for the first time in 11 years. That set off a gradual increase in unemployment. As the Reserve increased rates from 0.5 per cent then to 4.35 per cent now, unemployment has climbed from 3.5 per cent to 4.5 per cent – or about 150,000 people losing their jobs. That is a big sacrifice to pay on the altar of taming the inflation dragon down to a CPI of between 2 and 3 per cent.

The tragedy is that offering sacrifices to the low-inflation dragon might be as ineffectual as Aztecs butchering people atop pyramids in the hope of delivering rain. The theory is that if you take money out of disposable incomes, people will spend less so businesses will have to refrain from increasing prices if they want to keep attracting sales.

But businesses have to make a profit. If the cost of their inputs goes up, they have to pass some or all of that on to customers to stay profitable. And the price of business inputs has gone up because of the shock of the pandemic and the wars in Ukraine and the Middle East. Neither the Reserve Bank nor the government can do anything about those. Worse, if it increases interest rates in an attempt to get businesses to refrain from increasing prices, it only adds to business input costs (servicing debt) and makes them more likely to increase prices.

It is a vicious loop.

The loop can only be broken by dealing with government deficits in addition to or instead of central banks increasing interest rates. Metaphorically adding poison and traps to the frying pan assault on the mice plague.

In the US, the easiest way to ease pressure on interest rates would be to reverse the Trump tax cuts for the rich.

Similarly in Australia. Today will most likely will see another rate rise. That would have been unnecessary if the government had reduced its borrowing requirement. It has made a start with changes to the National Disability Insurance Scheme (NDIS), but it also needs to act on the revenue side. Collecting a fair tax for our gas resources would have dissolved the deficit.

The other social consequence of increasing interest rates is the shutting out of first-home buyers. Research by James Graham from the School of Economics at the University of Sydney shows that “a standard 0.25 percentage point increase in interest rates leads to an immediate five per cent decline in home purchases, and buying remains low for up to two years.”

As interest rates rise, fewer borrowers qualify to borrow, especially at the lower end of the market.

Mortgage repayments consume more than a third of mortgage-holders’ income, so any interest increase is a major contributor to the cost of living. Rate increases add to the feeling among voters that they are powerless and are going backwards, increasing the appeal of the simplistic solutions of far-right parties.

The Reserve Bank is independent but still beholden to the semi-religious dogma that increasing interest rates on its own cures inflation. But it does so at the cost of first-home buyers, debtors, and the job insecure and to the benefit of wealthy people who benefit from lower taxes and income from their capital.

The lesson for governments is: if you want to spend the money you have first to raise it with effective taxation. If not, you put pressure on interest rates and inflation, driving voters to the opportunists. If One Nation opposed effective taxation they would be exposed as friends of the billionaires, not, as they assert, on the side of the workers.

And central banks should look at the dangers of crashing the economy and people’s lives before blithely raising rates.

This article first appeared in The Canberra Times and other Australian media on 29 September 2026.

Republished from Crispin Hull

https://johnmenadue.com/post/2026/09/interest-rates-fighting-inflation-by-punishing-mortgage-holders-is-not-enough/

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