speech channels of transmission christopher kent [ * ] assistant governor ( financial markets ) address to bloomberg sydney – 11 october 2023 i want to thank bloomberg for organising this event. it ’ s great to be back at this venue. since may 2022, the reserve bank has raised the cash rate target by 400 basis points with the goal of bringing inflation back into its target range of 2 – 3 per cent. tighter monetary policy is working to slow the growth of demand and bring it into better balance with supply. this is contributing to the decline in inflation. today i want to show how increases in the bank ’ s cash rate target are transmitting through to demand and inflation. the most well - known element is the cash - flow channel, whereby a rise in the cash rate leads to higher interest payments for those who have debt, reducing the income borrowers have to spend on other things, leading to slower growth of demand and ultimately a decline in inflation. the cash - flow channel is felt with immediacy by borrowers with variable - rate debt and then with a lag for those with fixed - rate debt. it is this channel that is being felt most keenly at present, with many indebted households and businesses experiencing a painful squeeze on their finances. while this burden falls on only part of the population, there are other channels of monetary policy that spread across a broader range of people. indeed, in economies such as the united states where a sizeable share of borrowing – particularly mortgages – is at rates fixed over very long periods, these other channels of monetary policy do most of the heavy lifting. my talk today will focus on how monetary policy moves through the economy in three steps – from the cash rate to a broad range of interest rates, from those rates to economic activity and from economic activity to inflation. i will discuss the five main channels of monetary policy and the impact these are having in australia to bring down inflation. step 1 : from the cash rate to other interest rates the cash rate is the interest rate paid by banks that borrow from other banks in the overnight market. it is closely linked to other interest rates throughout the economy. when banks borrow at slightly longer terms – of say a month – they pay a similar rate of interest ( to what they expect the cash rate to be over that time ). if they faced a much higher rate, they would be better off borrowing overnight in the cash market and rolling that each day for the month. going the other way, banks can

substitution channel does not depend on whether borrowing and saving is at fixed or variable rates. this is because the channel works through the opportunity cost of spending versus saving, which depends on the current interest rates available to prospective borrowers and savers. hence, this channel should work in a similar fashion across different economies. see lane k and t rosewall ( 2015 ), ‘ firms ’ investment decisions and interest rates ’, rba bulletin, june. see jonathan hambur and gianni la cava ( 2018 ), ‘ do interest rates affect business investment? evidence from australian company - level data ’, rba research discussion paper no 2018 - 05. gibbs cg, j hambur and g nodari ( 2018 ), ‘ dsge reno : adding a housing block to a small open economy model ’, rba research discussion paper no 2018 - 04. higher interest rates may also reduce the supply of credit, which can influence the prices of assets that are typically purchased with borrowed funds, such as housing. for a review of recent wealth effect studies, see may d, g nodari and d rees ( 2019 ), ‘ wealth and consumption ’, rba bulletin, march. rba ( 2023 ), statement on monetary policy, august. based on current prudential requirements, when deciding how much they can lend to a prospective borrower, australian banks must assess the borrower ’ s ability to service the debt were interest rates to rise by a further 3 percentage points from current levels. see apra ( 2023 ), ‘ housing lending standards : reinforcing guidance on exceptions ’, letter to all authorised deposit - taking institutions ( adis ), 9 june. to get a sense of the orders of magnitude, our internal modelling suggests that a 100 basis point increase in the cash rate should lead, all else equal, to a 5 – 10 per cent appreciation in the trade - weighted exchange rate. the effect of such an appreciation would lead to an estimated reduction in inflation in the vicinity of ¼ to ½ of a percentage point after two years. many models imply that the intertemporal substitution channel is dominant, but this is by assumption in models that do not allow for credit constraints, which are relevant to several channels including the cash - flow, credit and asset - price channels. other models characterise the channels differently to how i ’ ve discussed them above – for example, some emphasise indirect employment effects, while others emphasise the role of redistribution between different