To encourage people to borrow more, the Reserve Bank reduces the base rate of interest or Official Cash Rate (OCR) . They then lend money to the banks at this rate of interest, and this interest rate generally feeds through into loans and mortgages.
This method of ‘steering’ the economy using interest rates is another great cause of instability. It is a little like driving a car by stepping on the brake and the accelerator at the same time.
When the economy is ‘overheating’, the banks have their foot on the accelerator (creating more money as debt) while the Reserve Bank has its foot on the brake (raising interest rates to slow down the borrowing).
When the economy sinks into a recession, they swap pedals - the banks slam on the brakes (reducing lending) and the Reserve Bank steps on the accelerator by cutting interest rates to their lowest level. This encourages people to get into debt in order to stimulate the economy.
This type of management of the economy will never lead to economic stability.
There is another huge social cost to managing the economy in this way. When interest rates are cut pensioners who were living off interest income from their savings are plunged into poverty.