Explaining the RBA cash rate with donut theory

So the cost of donuts has gone up $0.50 but before you write to your local member of parliament demanding a royal commission let’s have a think about the costs that go into making a donut. There’s yeast, cinnamon, oil, cream, jam, chocolate and the many other ingredients. If the cost of some or all of these ingredients increase, than it is logic and reality that the overall price we pay for the donut increases too.

Now let’s assume the price of jam, cream & yeast are all controlled by the one supplier, let’s say this supplier is a government organisation charged with ensuring the health and well-being of all Australians.

If we are eating too many donuts and risk becoming overweight & unhealthy, this organisation will increase the cost of jam, cream & yeast which will increase the price of donuts and we stop buying donuts.

If on the other hand we are not buying enough donuts, the donut making industry would cease to exist and thousands would be out of work so the supplier lowers the cost of jam, cream & yeast resulting in cheaper donuts and we buy more donuts allowing everyone to keep their jobs.

Now assume the donut maker is a Bank, the government organisation is the Reserve Bank of Australia (RBA) and the cash rate is jam, cream & yeast.

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