The Reserve Bank’s big interest rate shift this week marks a turning point for Australia.

After more than 10 years of falling interest rates, the RBA has begun the long march away from extreme cash rate settings. This welcome – and arguably belated – development will have profound implications for homeowners, investor portfolios, business capital allocation and government budgets after years of ultra-cheap money.

More than 1 million households have never experienced an official rate rise. Whoever wins the election will be forced to tighten the budget, despite the cash handouts and election goodies.

The proverbial inflation genie is out of the bottle around the world and central banks have been slow to respond. The big question now is, can central banks, including the RBA, dampen price pressures while avoiding a hard landing?

Monetary policy takes about 12 to 18 months to have its full impact – what economists call the “lag” effect. So, the RBA will be feeling its way through the dark, raising interest rates in the near term while trying to guess the impact of higher rates more than a year into the future.

To be sure, there will be some real-time immediate evidence of higher rates on consumer spending, home borrowing and the stock market. But the full effect will not be known until well after the tightening occurs. It’s a tricky task, requiring a lot of guesswork.

Tighten too slowly and the RBA risks inflation running out of control as it is in the United States and United Kingdom. Raise rates too aggressively and it could tip the economy into recession in two to three years from now. Read more