Assignment – RBA Monetary Policy and Inflation Targeting: A 2022-2025 Analysis

Introduction

The inflation surge that followed the COVID-19 pandemic subjected Australia’s monetary policy framework to its sternest test since inflation targeting was adopted in 1993. Headline inflation reached 7.8 per cent over the year to the December quarter 2022, the fastest pace since 1990, while the cash rate entered the episode at a record low of 0.10 per cent (ABS 2025). This assignment examines how the Reserve Bank of Australia (RBA) deployed its flexible 2-3 per cent inflation target across the 2022-2025 cycle. It outlines the institutional framework, documents the tightening and easing phases against the quarterly path of the Consumer Price Index (CPI), analyses the transmission mechanism with a worked real interest rate calculation, and assesses the uneven distributional consequences for mortgage holders and savers, before evaluating the framework in light of the 2023 RBA Review and considering the outlook. The central argument is that flexible inflation targeting performed its core task, returning inflation to the band while preserving most of the post-pandemic employment gains, but that the episode exposed communication weaknesses and distributional costs that the current reforms only partly address.

The Inflation-Targeting Framework

Australia’s inflation target emerged pragmatically in the early 1990s rather than by statute. The RBA began articulating a goal of holding consumer price inflation between 2 and 3 per cent, on average, over the economic cycle, a formulation ambitious enough to anchor expectations yet flexible enough to absorb temporary shocks (Debelle & Stevens 1995). The target was formalised in the first Statement on the Conduct of Monetary Policy in 1996, an agreement between the Treasurer and the Governor renewed with each change of leadership, while the statutory foundation remains the Reserve Bank Act 1959 (Cth) and its objectives of currency stability, full employment and the economic prosperity and welfare of the Australian people.

Three design features distinguish the Australian approach. First, the target is a band rather than a point, acknowledging measurement error and the imprecision of policy control. Second, it is expressed “on average, over time”, giving the Board discretion over how quickly deviations are corrected. Third, since the December 2023 Statement on the Conduct of Monetary Policy, price stability and full employment have been framed as an explicit dual mandate of equal weight, with the Bank now aiming at the 2.5 per cent midpoint of the band (Australian Treasury & RBA 2023). The economic logic is that a credible target anchors inflation expectations, which in turn shape wage bargaining and price setting, so policy needs to do less work in response to any given shock (Friedman 1968; Mishkin 2019).

The 2022-2025 Tightening and Easing Cycle

Pandemic-era policy left an unusually stimulatory starting point: a 0.10 per cent cash rate, a term funding facility for banks, large-scale bond purchases and calendar-based guidance that rate rises were unlikely “until 2024 at the earliest”. Inflation then accelerated far faster than forecast. Global supply chain disruption, the energy shock following Russia’s invasion of Ukraine, the 2022 east-coast floods that lifted fresh food prices, and surging home-building costs collided with stimulus-supported household demand (Lowe 2023). As shown in Table 1, headline inflation climbed from 5.1 to 7.8 per cent during 2022, and the trimmed mean, the RBA’s preferred measure of underlying inflation, peaked at 6.9 per cent.

Table 1: Cash rate target and annual inflation, selected quarters, 2022-2025

Source: compiled from ABS (2025) and RBA (2025) data.

The response was the steepest tightening since the early 1990s: thirteen increases between May 2022 and November 2023 took the cash rate from 0.10 to 4.35 per cent. Two features of the strategy stand out. First, the RBA deliberately stopped below the peaks reached by the United States Federal Reserve and the Reserve Bank of New Zealand, accepting a slower return to the band in exchange for protecting employment, the “narrow path” (Lowe 2023). Second, the Board then held the rate at 4.35 per cent for fifteen months while the long transmission lags worked through. With underlying inflation back below 3 per cent, easing began in February 2025, taking the cash rate to 3.85 per cent by the June quarter and 3.60 per cent in August 2025 (RBA 2025).

The Transmission Mechanism

Figure 1 summarises the causal chain through which the cash rate reaches inflation. As the interest rate on overnight interbank funds, the cash rate anchors the structure of deposit and lending rates. Higher lending rates restrain demand through overlapping channels: the cash-flow channel, which shifts disposable income from borrowers to lenders; intertemporal substitution, as saving becomes more attractive than spending; the wealth channel, as asset prices soften; and the credit channel, as collateral values and lending standards tighten (Bernanke & Gertler 1995; Kent 2023). A higher cash rate also supports the Australian dollar, directly lowering import prices. Weaker aggregate demand then slows price and wage growth.

Australian institutional features make the cash-flow channel unusually powerful. Household debt stands near 185 per cent of disposable income, among the highest in the OECD, and most mortgage debt is variable-rate, so pass-through to repayments is rapid (Kent 2023; OECD 2023). The pandemic temporarily muted this channel: roughly two fifths of new lending in 2020-21 was fixed near 2 per cent, and the expiry of those loans through 2023, the fixed-rate cliff, delivered a delayed wave of tightening. Transmission therefore operates with the “long and variable” lags identified by Friedman (1968), the RBA placing the peak effect on activity at roughly 12-18 months after a rate change.

Measuring the Policy Stance: A Real Interest Rate Calculation

Because spending decisions respond to inflation-adjusted returns, the stance of policy is better read from the real cash rate than the nominal rate. Applying the Fisher relation, with the trimmed mean as a proxy for short-run expected inflation (Mishkin 2019):

Real cash rate = nominal cash rate – expected inflation

December quarter 2022: real cash rate = 3.10 – 6.9 = -3.80 per cent

December quarter 2024: real cash rate = 4.35 – 3.2 = +1.15 per cent

The calculation reveals a striking fact: after eight months and 300 basis points of tightening, policy was still highly stimulatory in real terms at the end of 2022. Only during 2023-24 did the real rate rise above the RBA’s estimate of the neutral real rate of around 1 per cent, so the stance became genuinely restrictive well after the nominal peak (RBA 2025). This is why judging policy by nominal movements alone misleads, and why the Board kept tightening into a visibly slowing economy.

Distributional Effects: Mortgage Holders versus Savers

Monetary policy is a blunt instrument whose costs are not shared evenly. Roughly one third of Australian households hold a mortgage, one third own their home outright and one third rent, so the direct cash-flow burden of tightening fell on a minority (ABS 2025). Its scale is evident from the standard amortisation formula for the monthly repayment M on principal P:

M = P × [r(1 + r)ⁿ] / [(1 + r)ⁿ – 1]

For a $600,000 loan over 25 years (n = 300) at the peak average variable rate of 6.4 per cent (r = 0.064 / 12 = 0.005333):

M = 600,000 × (0.005333 × 4.932) / 3.932 ≈ $4,014 per month

against approximately $2,814 at the pre-tightening rate of 2.9 per cent, an increase of about $1,200 per month, or 42.6 per cent. Table 2 extends the calculation across common loan balances.

Table 2: Estimated monthly repayments, 25-year variable-rate loan, pre-tightening versus peak rates

Two safeguards cushioned the shock. The Australian Prudential Regulation Authority requires new loans to be assessed at 3 percentage points above the contracted rate, so most borrowers had already demonstrated capacity to service repayments near peak rates (APRA 2021), and households had accumulated large buffers in offset and redraw accounts during the pandemic. Arrears consequently rose only modestly, although discretionary consumption fell sharply and real GDP per capita contracted through much of 2023-24 even as an aggregate recession was avoided.

Savers sat on the other side of the ledger. Older households holding net interest-bearing assets earned their first material deposit returns in a decade, with term deposit rates moving above 4.5 per cent. The benefit was smaller than the arithmetic suggests, however: the Australian Competition and Consumer Commission’s Retail Deposits Inquiry found pass-through to deposit rates slower and less complete than to lending rates, and often confined to conditional bonus products whose criteria many customers fail to meet in a given month (ACCC 2023). Renters were exposed indirectly, with CPI rents rising around 7-8 per cent annually through 2023-24, driven principally by record-low vacancy rates and strong population growth, with higher investor funding costs a contributing pressure (ABS 2025). The episode therefore redistributed income from younger, indebted households towards older savers, an intergenerational pattern the framework itself cannot resolve (Bullock 2023).

Evaluating the Framework and the RBA Review Reforms

Judged against its core objective, the framework performed well. Long-run inflation expectations remained anchored near 2.5 per cent throughout the episode, which is precisely the credibility dividend targeting is designed to buy; disinflation of almost six percentage points was achieved without a technical recession; and unemployment rose only from its fifty-year low of 3.5 per cent to around 4.2 per cent by mid-2025 (Bullock 2023; RBA 2025). The flexibility of the “on average, over time” formulation was used exactly as intended, trading a slower return to target for the preservation of employment gains.

The episode nonetheless exposed real weaknesses. The calendar-based guidance of 2021 was heard by many borrowers as a promise, and its abandonment damaged credibility at the very moment tightening began. Policy also had limited traction on the supply-driven components of the surge, such as global goods prices, energy and insurance premiums, so the burden of adjustment fell on interest-sensitive sectors regardless of where inflation originated. These concerns motivated the independent Review of the RBA, whose report made 51 recommendations (de Brouwer, Fry-McKibbin & Wilkins 2023). The resulting reforms, legislated through the Treasury Laws Amendment (Reserve Bank Reforms) Act 2024 (Cth) and summarised in Table 3, reshape governance and communication while deliberately retaining the 2-3 per cent target.

Table 3: Key RBA Review reforms and implementation status, mid-2025

The reforms are best read as evolution rather than revolution. A specialist Monetary Policy Board whose external members can outvote the Governor, published votes and regular press conferences import international best practice on deliberation and accountability (OECD 2023). What they do not change is the trade-off 2022-2025 exposed: one instrument cannot simultaneously deliver price stability, full employment and distributional fairness, so the speed of disinflation remains a judgement for which the Board must now account far more publicly.

Outlook

As at the second half of 2025 the disinflation appears secure, with headline inflation of 2.1 per cent and trimmed mean inflation of 2.7 per cent both consistent with the band (ABS 2025). The RBA’s forecasts have inflation settling near the 2.5 per cent midpoint through 2026, supporting gradual easing towards estimates of the nominal neutral rate of around 3 per cent (RBA 2025). Three risks cloud this trajectory. Weak productivity growth means unit labour costs are rising faster than is consistent with the midpoint, threatening persistence in services inflation. Global trade disruption, including the tariff measures introduced by the United States in 2025, combines weaker growth with ambiguous price effects. Housing supply shortfalls continue to hold rent inflation well above its historical average. The easing phase will also be the first full test of the reformed Monetary Policy Board’s communication framework.

Conclusion

The 2022-2025 cycle demonstrated both the resilience and the limits of Australia’s flexible inflation-targeting framework. Confronted with the largest inflation shock in three decades, the RBA lifted the cash rate from 0.10 to 4.35 per cent, held it while long transmission lags did their work, and returned headline and underlying inflation to the 2-3 per cent band by 2025 without recession and with only a modest rise in unemployment. The real interest rate calculation showed that policy remained stimulatory in real terms deep into the tightening phase, vindicating the Board’s persistence even as the cash-flow burden on mortgaged households mounted. Those costs were real and unevenly distributed, falling hardest on younger, indebted households while only partially compensating savers. The RBA Review reforms address the governance and communication failures the episode revealed, but the harder questions, the distributional incidence of a single blunt instrument and the economy’s exposure to supply-driven shocks, remain open for the framework’s next test.

References

Australian Bureau of Statistics (ABS) 2025, Consumer Price Index, Australia, June quarter 2025, cat. no. 6401.0, ABS, Canberra.

Australian Competition and Consumer Commission (ACCC) 2023, Retail Deposits Inquiry: Final Report, ACCC, Canberra.

Australian Prudential Regulation Authority (APRA) 2021, APRA increases banks’ loan serviceability expectations to counter rising risks in home lending, media release, APRA, Sydney, 6 October.

Australian Treasury & Reserve Bank of Australia 2023, Statement on the Conduct of Monetary Policy, Commonwealth of Australia, Canberra.

Bernanke, BS & Gertler, M 1995, ‘Inside the black box: the credit channel of monetary policy transmission’, Journal of Economic Perspectives, vol. 9, no. 4, pp. 27-48.

Bullock, M 2023, ‘Monetary policy in Australia: complementarities and trade-offs’, address to the Australian Business Economists dinner, Sydney, 22 November.

de Brouwer, G, Fry-McKibbin, R & Wilkins, C 2023, An RBA Fit for the Future: Review of the Reserve Bank of Australia, Commonwealth of Australia, Canberra.

Debelle, G & Stevens, G 1995, ‘Monetary policy goals for inflation in Australia’, Research Discussion Paper no. 9503, Reserve Bank of Australia, Sydney.

Friedman, M 1968, ‘The role of monetary policy’, American Economic Review, vol. 58, no. 1, pp. 1-17.

Kent, C 2023, ‘Channels of transmission’, address to Bloomberg, Sydney, 11 October.

Lowe, P 2023, ‘Monetary policy, demand and supply’, address to the National Press Club, Sydney, 5 April.

Mishkin, FS 2019, The Economics of Money, Banking and Financial Markets, 12th edn, Pearson, Harlow.

Organisation for Economic Co-operation and Development (OECD) 2023, OECD Economic Surveys: Australia 2023, OECD Publishing, Paris.

Reserve Bank of Australia (RBA) 2025, Statement on Monetary Policy, May 2025, RBA, Sydney.