Most households with mortgages have a fairly simple attitude to the Reserve Bank of Australia: They like it when it keeps rates low and are annoyed when it raises them.

Yet, anyone with any understanding of economics knows that central banks such as the RBA sometimes have to be cruel to be kind. In other words, they have to lift rates to control inflation and stop the economy overheating and then bursting.

The question that will be at the centre of the review into the Reserve Bank – which Treasurer Jim Chalmers announced on Wednesday – is whether the RBA is getting the balance right.

Even the RBA admits that it has made mistakes. In the years before the global pandemic, it overestimated the risk of inflation and kept rates too high.

As it turned out, before 2020, inflation was not about to explode and indeed it stayed well below the 2 to 3 per cent range, which the Reserve Bank is supposed to target. The RBA’s high rate settings hurt the economy, resulting in an unemployment rate that was rather higher than necessary.

Last year, the RBA may also have messed up in the opposite direction, by keeping rates too low for too long.

Its decision to cut rates to near zero when the pandemic hit worked as a backstop while the economy was in crisis. However, the RBA failed to spot the recovery that started this year and its easy money policy caused excess demand, which was one of the factors that pushed inflation up to its current level of 5.1 per cent.

Now the Reserve Bank is scrambling and raising rates in 0.5 percentage-point bursts, faster than it has for 30 years. Some households will suffer.

RBA governor Philip Lowe admitted in May that the forecasts last year were “embarrassing”. On Wednesday, he said, “With hindsight, I can understand why some people might conclude that too much support was provided by governments and central banks.”

The review will have to look at how these mistakes occurred as part of a much broader inquiry into issues such as the composition of the bank’s board, the way the RBA forecasts economic trends and how it communicates decisions to the public.