Foundations: the ideas everything else builds on

An economy is people working, making and exchanging things. Three activities go round in a loop. Production: farms, hospitals, cafés and mines turn people's time, skills and materials into goods and services. Income: the people and businesses who produce earn wages, profits, rent and interest. Spending: that income is spent on what others produce, which becomes their income in turn.

The loop has one simple rule worth holding onto: every dollar spent on goods and services is a dollar of income for someone else.

Economists usually group the players into four sectors:

• Households, who work, consume, save and borrow.
• Firms, from a sole trader in Merewether to BHP, who hire, produce and invest.
• Government, which taxes, spends, employs and makes the rules.
• The rest of the world, which buys our exports, sells us imports and invests here.

It helps to keep two layers apart. The real economy is the actual stuff: hours of nursing, tonnes of wheat, houses, broadband, ideas. The money side is the set of payments, debts and accounts that organises who gets what. Money matters a great deal, because it decides who can command real resources. But a country's living standards ultimately depend on what it can produce and import, not on the numbers in its accounts. Much of this site is about how those two layers fit together.

The RBA describes money by what it does. It is a widely accepted means of payment, a unit of account (prices are written in dollars) and a store of value (you can hold it now and spend it later).

In Australia, two kinds of money are used by the public:

• Currency: banknotes and coins. Notes are produced by the RBA and are its liability: something the RBA owes the holder. Coins are made by the Royal Australian Mint.
• Bank deposits: the balance in your transaction or savings account. This is by far the larger part. In July 2018 Australians held about $74 billion in currency out of a broad money stock of about $2,096 billion, around 3.5 per cent.

Credit is a promise to pay later. If you borrow $20 from a friend until Friday, you have created a small IOU. Modern money is also a set of IOUs: a banknote is the RBA's promise, and a deposit is your bank's promise to you. What makes some IOUs money is that almost everyone will accept them in payment, so they can pass from hand to hand. Your IOU to your friend is credit, but it is not money, because the supermarket will not take it.

Why people accept the Australian dollar at all, whether mainly because of taxes payable in it, legal tender rules, habit or trust that it will hold its value, is debated. The first topic on this site sets out the competing views.

Money in Australia sits in two layers of accounts.

Layer one: you and your bank. Households and businesses hold deposits at commercial banks, building societies and credit unions. Your deposit is your bank's liability.

Layer two: banks and the RBA. Banks hold their own accounts at the Reserve Bank, called Exchange Settlement accounts. The balances in them, often called reserves, are how payments between banks are finally settled. Only certain institutions can hold one: authorised deposit-taking institutions (ADIs), some other payment providers, and licensed clearing and settlement facilities. You, your employer and the local council cannot.

When you pay someone who banks elsewhere, both layers move. Your deposit falls and theirs rises, and behind the scenes your bank pays their bank by transferring Exchange Settlement balances at the RBA. Banks must keep these balances above zero. A bank that is short can borrow overnight from another bank, at an interest rate called the cash rate, or borrow from the RBA at its weekly market operations, at a rate a little above the cash rate target. The RBA pays interest on Exchange Settlement balances at 0.1 percentage points below its cash rate target (as of 2026).

The government banks with the RBA too. When it spends, banks' Exchange Settlement balances rise; when people pay tax or buy new government bonds, they fall.

One common mistake to avoid: banks do not lend their reserves to households or businesses, who cannot hold them. Reserves are used to settle payments between banks.

Not all dollars are the same kind of promise. Economists often describe a hierarchy of money.

At the top is money issued by the state. In Australia that means RBA banknotes and Exchange Settlement balances, plus coins issued by the Commonwealth. The RBA notes that currency is backed by the central bank, which eliminates any risk of default.

Below that is commercial bank money: your deposit. It is a private bank's promise, and it works as money because the bank promises to convert it into state money at par, one for one, whenever you ask: as cash over the counter, or as a payment to another bank settled in reserves. Most of the time nobody tests that promise, so people treat deposits and cash as interchangeable.

Why is the bank's promise trusted? Banks are regulated by APRA, which requires them to hold capital to absorb losses and liquid assets to meet withdrawals. And there is a backstop. Under the Financial Claims Scheme, an Australian Government scheme administered by APRA if it is activated, deposits with ADIs incorporated in Australia are protected up to $250,000 per account holder per ADI (the cap since 2012; check APRA for any change). Some banking brands share one licence, so the cap applies across them; APRA lists which brands belong to which ADI.

The layers matter later on this site. When the government spends, it adds to the top layer; when banks lend, they create the lower layer. When people doubt the lower layer, they rush to swap it for the top one, which is what a bank run is.

A balance sheet is a snapshot of a person's or an organisation's finances on one day.

• Assets are what you own or are owed: a house, a car, a bank deposit, shares, superannuation.
• Liabilities are what you owe: a mortgage, a car loan, a credit card balance.
• Net worth (called equity or capital for a business) is assets minus liabilities.

Some assets are real: a house or a tractor exists whether or not anyone owes anything. Others are financial: a deposit, a bond or a loan is a claim on someone else. Here is the key idea: every financial asset is someone else's liability. Your $1,000 deposit is an asset to you and a liability of your bank. Your mortgage is a liability to you and an asset to your bank.

Two consequences follow. First, every transaction changes at least two entries, which is why accountants call it double-entry bookkeeping. Second, if you add up every financial asset and every financial liability in a closed system, they cancel. So borrowing between households, firms and banks can move money around and create new deposits, but it cannot by itself make the private sector richer in net financial terms. That point returns when we compare bank lending with government deficits.

A useful habit for the rest of the site: whenever someone says money was "created" or "destroyed", ask whose asset changed and whose liability changed with it.

GDP is the most quoted number in economics. It measures the value of all the final goods and services produced in Australia over a quarter or a year. Because one person's spending is another's income, it can be measured three ways, which in principle give the same answer:

• Production: add up the value each industry adds, from mining to health care.
• Income: add up wages, profits and other incomes earned from that production.
• Expenditure: add up spending on it by households, businesses, government and overseas buyers, minus what we import.

In practice the three measures differ a little, and the ABS and most economists focus on their average.

Nominal GDP is measured in today's dollars, so it rises when prices rise even if nothing extra is produced. Real GDP strips out price changes to show changes in the volume of output. When people talk about economic growth, they usually mean real GDP.

GDP also leaves a lot out. Unpaid childcare by parents is not counted, while paid childcare is. It says nothing about how income is shared, or about damage to the environment. Spending to rebuild after a flood adds to GDP without making anyone better off than before the flood. So GDP measures market activity, not wellbeing.

You will often see things measured as a share of GDP, such as debt, deficits or tax. That simply scales a dollar figure to the size of the economy, so years and countries can be compared.

Inflation is a rise in prices across the economy, not just in one thing. A jump in avocado prices after a bad season is not inflation by itself; prices rising for groceries, rents, insurance and haircuts all at once is.

In Australia, inflation is measured by the Consumer Price Index (CPI), produced by the ABS. It tracks the cost of a large basket of goods and services bought by households. Since late 2025 the complete monthly CPI has been the main headline measure. The RBA also watches "underlying" measures, such as the trimmed mean, which set aside the most extreme price moves each period.

The RBA's target is to keep annual CPI inflation between 2 and 3 per cent, and it sets policy aiming to return inflation to the midpoint, 2.5 per cent.

Keep two ideas apart:

• The price level is how high prices are.
• The inflation rate is how fast that level is rising.

When inflation falls from 7 per cent to 3 per cent, prices are still rising, only more slowly. They do not go back down. Falling prices across the economy are called deflation, which is rare and usually a sign of a weak economy.

Inflation matters because it changes what money is worth. If your wages or savings grow more slowly than prices, you can buy less than before. Over 2022, CPI inflation reached 7.8 per cent, the highest since 1990. What caused it is debated; the inflation topic sets out the competing explanations.

Aggregate demand is all the spending on Australian-produced goods and services: household consumption, investment by businesses and households (such as new equipment and new homes), government spending, and exports, minus the part of all that spending that goes on imports.

Aggregate supply is what the economy can produce with the workers, skills, equipment, materials and energy it has. The level of output it can sustain without prices speeding up is called potential output, or full capacity.

Put them together and you get the basic macroeconomic question. If spending is below capacity, there are idle workers and empty order books, and output can grow without much pressure on prices. If spending runs ahead of capacity, businesses can raise prices and still sell everything, and they compete harder for scarce workers. The RBA calls this demand-pull inflation.

Shocks can come from either side:

• A demand shock is a sudden change in spending, such as households cutting back in a recession or a large stimulus package. It usually pushes output and prices in the same direction.
• A supply shock is a sudden change in what can be produced or what it costs, such as an oil price spike, floods destroying crops, or pandemic shipping bottlenecks. A bad supply shock pushes prices up while output goes down. In the worst case, that is stagflation.

The difference matters for policy: higher interest rates work mainly by reducing demand, and cannot add oil or ships. How close the economy usually runs to its capacity is debated; the last concept on this page takes that up.

Each month the ABS surveys about 24,000 households for its Labour Force survey and sorts everyone aged 15 and over into three groups, based on one reference week:

• Employed: worked at least one hour for pay (or unpaid in a family business) in the reference week, or had a job but was away from it, for example on leave.
• Unemployed: had no paid work, actively looked for work in the past four weeks, and was available to start.
• Not in the labour force: everyone else, such as retirees and many students and carers.

The labour force is the employed plus the unemployed. The unemployment rate is the unemployed as a share of the labour force, not of the whole population. The participation rate is the labour force as a share of everyone aged 15 and over.

Because one hour of paid work counts as employed, the ABS also measures underemployment: people with a job who want, and are available for, more hours. In August 2026 unemployment was 4.6 per cent and underemployment 6.2 per cent.

Unused workers are the most visible sign of spare capacity, but there is also idle equipment, empty shops and unused skills. Economists sum this up with the output gap: actual output minus potential output. A negative gap means spare capacity; a positive gap means the economy is running hot, with pressure on prices. Potential output cannot be observed, only estimated, so the gap is always uncertain.

The RBA describes full employment as as many people in jobs as possible while keeping inflation low and stable, which it says does not mean zero unemployment. How low unemployment can safely go is one of the site's central debates.

Fiscal policy is what the government does with its budget: spending, taxes and payments such as pensions and JobSeeker. Treasury describes its jobs as allocating resources, redistributing income and stabilising the economy. In Australia:

• The Government, through Cabinet and its Expenditure Review Committee, decides policy.
• Parliament passes the laws that authorise spending and set taxes.
• Treasury advises on the economy, the budget and tax, and the Department of Finance manages the government's accounts.
• The AOFM manages the government's cash and debt.

Some fiscal support happens automatically. In a downturn, tax receipts fall and more people claim unemployment payments, which cushions spending without any new decision. Economists call these automatic stabilisers.

Monetary policy is run by the Reserve Bank. Since March 2025, decisions have been made by its Monetary Policy Board: nine members, chaired by the Governor and including the Secretary to the Treasury. Its main tool is the cash rate target. At times it has also used forward guidance, cheap term funding for banks, a target for a government bond yield, and bond purchases. Its objectives, agreed with the Treasurer, are inflation of 2 to 3 per cent and sustained full employment. It sets policy independently of the government.

This division of labour is a choice, not a law of nature. The mainstream view gives monetary policy the main job of managing demand day to day. MMT economists argue fiscal policy should take the lead, with interest rates kept low and steady. That is an argument, and the government-spending topic weighs it.

Think of a bathtub. The deficit is the water flowing in this year: spending minus revenue. A surplus is water draining out. The debt is the water already in the tub, built up over many years.

Flows are measured over a period; stocks at a point in time. Mixing them up causes a lot of confusion. A smaller deficit still adds to debt, just more slowly. Debt only falls in dollar terms when the budget is in surplus.

When the Australian Government spends more than it collects, the AOFM issues Treasury Bonds and Treasury Notes to cover the gap, so deficits add to the stock of government securities on issue. In practice debt grows faster than the headline deficit. The government also borrows for investments that the 'underlying' deficit leaves out, such as student loans and policy funds, and debt is counted at face value. In the 2026–27 Budget, a $31.5 billion underlying deficit comes with a $69 billion rise in gross debt. Those securities are financial assets, held by banks, super funds, insurers, overseas investors and the RBA.

Some figures, from the May 2026 Budget: an underlying cash deficit forecast of $31.5 billion for 2026–27, 1.0 per cent of GDP, and gross debt of $1,051 billion, 34.0 per cent of GDP, at 30 June 2027. Budget forecasts are updated every year, so check the latest budget before quoting them.

Debt is usually reported as a share of GDP because that scales it to the size of the economy. A ratio can fall even while the dollar amount rises, if the economy grows faster than the debt.

Deficits also move with the economy. In a recession, revenue falls and payments rise automatically, so the deficit widens without any new decision. How much deficits and debt matter for a country that issues its own currency is debated; the government-spending topic sets out both sides.

A bond is a loan you can sell to someone else. The buyer pays the issuer now; the issuer promises fixed interest payments (the coupon) and the face value back at maturity.

The Australian Government's securities are issued by the AOFM. The main types are Treasury Bonds (fixed coupons, maturities out to decades), Treasury Indexed Bonds (adjusted for inflation) and Treasury Notes (short-term). Most are sold by tender: a 15-minute competitive auction open to registered bidders, usually banks. The AOFM sets how much it will sell and of which bond; the bidders' prices set the yield.

After issue, bonds trade in the secondary market. Their price moves with interest rates, in the opposite direction to their yield, the return a buyer locks in. If new bonds offer more than an old one, nobody will pay full price for the old one, so its price falls until its yield matches.

Who holds Australian government bonds? Banks, super funds and insurers, overseas investors such as other central banks and funds, and the RBA itself, which bought bonds from existing holders during 2020–22.

The RBA describes government bond yields as risk-free in their own currency, because governments are not expected to default on debt in their own currency. Treasury describes bond issuance as how the government borrows to fund deficits. MMT economists describe the same sales as offering investors an interest-bearing alternative to reserves, rather than something spending depends on. Both describe the same transactions; the government-spending topic explains the disagreement.

Interest is what a borrower pays a lender for the use of money, usually quoted per year.

The cash rate is the rate banks charge each other for overnight loans of Exchange Settlement balances. The RBA's Monetary Policy Board sets a target for it and keeps the actual rate close to the target through its market operations and the rates it pays and charges on those balances. Between May 2022 and November 2023 the Reserve Bank Board, which made rate decisions before 2025, raised the target thirteen times, from 0.10 to 4.35 per cent.

How it passes through. The cash rate shapes what banks pay for their funding, and so what they charge. Variable mortgage and business loan rates usually move soon after a change. Deposit rates tend to respond more slowly, because banks have more discretion over them. Pass-through is not one for one, and competition and the riskiness of each borrower also matter. Fixed mortgage rates and longer-term bond yields depend partly on where markets expect the cash rate to go, and partly on global rates and other factors. The RBA says monetary policy takes one to two years to have its full effect, with a lot of uncertainty.

Nominal and real. The rates you see quoted are nominal. The real interest rate adjusts for inflation: roughly, the nominal rate minus inflation. It tells you what a lender really gains, and a borrower really pays, in purchasing power. A 6 per cent mortgage rate is a heavy burden when inflation is 1 per cent, and much lighter when inflation is 5 per cent.

What is established. Two questions sort out most of the difference: who owes, and in what currency?

Australian Government debt is in Australian dollars, owed to the holders of its bonds: banks, super funds, overseas investors and the RBA. A government that issues its own floating currency cannot be forced to default on debt in that currency, though it still pays interest.

Private debt is owed by households and businesses, mostly to banks. Borrowers cannot create Australian dollars; they must earn them, so they can default, and when many cut spending at once to repay debt, the whole economy slows. Historical research across many countries finds rapid growth in private credit is a powerful predictor of financial crises.

Governments that borrow in a currency they do not issue, as in the euro area, are closer to a household's position. About three-quarters of Australia's foreign liabilities are in Australian dollars (2022).

Where this is contested. How much each kind of debt matters is argued, not settled.

• Mainstream economists, including at the RBA, treat private debt as a serious financial stability risk. They argue public debt matters too: interest competes with other spending, large deficits at full employment can add to inflation, and high debt can reduce room in a crisis. Olivier Blanchard argues its costs are smaller while interest rates stay below growth.
• MMT and post-Keynesian economists, in Hyman Minsky's tradition, argue that private debt is the main source of financial fragility, and that public debt in a country's own currency is the private sector's safe savings.

Split the economy into three sectors: the government, the domestic private sector (households and businesses together) and the rest of the world. For each, compare income with spending over a year. A sector that spends less than its income runs a surplus and adds to its financial assets; one that spends more runs a deficit.

Because every dollar one sector spends is a dollar another receives, the three balances must sum to zero:

private balance + government balance + rest-of-world balance = 0

The rest of the world's balance is the mirror image of Australia's current account: when Australia runs a current account deficit, the rest of the world runs a surplus with us. The RBA puts the same logic another way: the current account equals the difference between national saving and investment.

So if the government runs a deficit, the other two sectors together must run a surplus of exactly the same size. That is why people say the government's deficit is the non-government sector's surplus, to the dollar.

This is an identity, true by definition, like assets equalling liabilities plus net worth. Economists of every school accept it. What it does not do is just as important:

• It does not say what the deficit should be.
• It does not say which balance causes which. A deficit may follow a spending decision, or a recession that cut tax receipts while households saved more.

Those questions need theory and evidence, and that is where the real disagreements lie.

Since December 1983 the Australian dollar has floated: its price is set by supply and demand in foreign exchange markets, not fixed by the government. The RBA points to three main drivers:

• The terms of trade: when prices for our commodity exports rise relative to import prices, the dollar tends to rise.
• Interest rate differences: higher Australian rates relative to other countries tend to attract foreign money and lift the dollar.
• Risk sentiment: the dollar tends to rise when global investors are confident and fall when they are nervous.

Trade links us to the rest of the world. Exports are what we sell, such as iron ore, gas and education. Imports are what we buy, such as fuel, machinery and medicines. Exports minus imports is the trade balance. Add income flows such as interest and dividends paid to and from overseas, and you get the current account.

The current account is always offset by the capital and financial account, which records who buys whose assets. If Australia buys more from the world than it earns, foreigners must be adding the difference to their holdings of Australian assets. That is an identity, not a judgement. Australia has run current account deficits for most of the past 50 years; its net foreign liabilities were $638.9 billion at 30 June 2026. About three-quarters of its foreign liabilities were in Australian dollars in 2022, which matters when the dollar falls.

A lower dollar makes our exports cheaper abroad and imports dearer at home. The RBA says the full effects take one to three years.

Everything produced uses real resources: workers, skills, materials, energy, land and equipment. There is only so much of each at any moment: that is scarcity. The opportunity cost of a choice is the best alternative you give up: the electricians wiring a new hospital are not, that month, wiring new homes.

What is established. The Australian Government issues the Australian dollar, so it cannot run out of dollars to pay for things priced in dollars. Mainstream critics of MMT, such as Gregory Mankiw, accept this. Running out of money is not the risk. What limits spending is whether the workers and materials exist, and whether more spending pushes up prices. Exchange-rate, legal and political limits also apply.

Where this is contested. The disagreement is about how close those real limits usually are, and whether debt adds a financial limit of its own.

• Mainstream economists stress that the economy tends to run near capacity over time, partly because the RBA aims to keep it there. Then extra public spending has a real opportunity cost: resources must be drawn from other uses, through taxes, higher interest rates or higher prices. Mankiw and others also stress the government's budget constraint over time: debt must eventually be serviced through taxes or inflation, so interest costs and debt levels matter even below full capacity.
• MMT economists agree that real resources and inflation are the true limits. In Randall Wray's words, it is "too much spending", not "too much money", that is the inflation danger. But they argue economies usually have substantial spare capacity, counting underemployment too, so well-targeted spending can often use idle resources at little real cost. They see interest costs as largely a policy choice, because the central bank sets the short-term rate.

Settling it needs evidence on how much spare capacity exists, and on how inflation responds when spending rises. Each side reads the 2021–23 inflation differently.