The Reserve Bank met on Tuesday and decided to expand its emergency monetary policy into a fully fledged program of so-called quantitative easing (QE) to help the economy recover from the coronavirus crisis.
What is quantitative easing?
It sounds very technical but it boils down to the RBA printing money to pump funds through the financial system. The bank can do this by buying up government bonds and other financial assets from banks and pensions funds, thereby flooding the system with liquidity. The hope is that the financial institutions will use the extra funds to increase lending to households and businesses. It’s often referred to as a “money printing scheme” although the actual funds used to buy the bonds are created and exist electronically and not as printed notes.
What has the RBA done so far?
When the pandemic struck in March, the central bank cut the cash rate to 0.25%, making borrowing cheaper than it has ever been in Australian history. It also announced that it would start buying government bonds so that the yield, or interest rate, on 3-year bonds would also fall to a target of 0.25%. This was known as “yield curve control” and is not the all-out QE program seen on other countries, although many Australian observers regard it as QE by any other name. Yields on bonds move in the opposite direction to the actual price, so when the RBA increased demand for 3-year bonds with its market intervention, the prices rose and yields fell. The RBA has so far spent more than $50bn on buying up bonds. Another part of the March package was a three-year funding facility for at least $90bn to be lent to banks at a fixed rate of 0.25%, further easing liquidity.
So what has changed now?
Having deployed the bazooka back in March, the denizens of Martin Place have rolled up the really big guns and unleashed a full program of QE that will see it pump $100bn into the financial system. Along with cutting the cash rate to 0.1% and reducing the 3-year bond target to the same figure, Phillip Lowe has mapped out a wider purchasing scheme that will include 5- and 10-year bonds.
Why is the RBA doing this?
The financial system has come under severe pressure as a result of the pandemic-driven squeeze on the global economy. Just like businesses and households facing loss of trade and wages, the financial system needs money to keep it going. Central banks normally ease this by lowering interest rates but the RBA, like every other major central bank in the world, has already cut them to unprecedented lows. The cash rate in Australia was 0.25% and the RBA has now cut it to 0.1%. But many economists argue that anyone who wanted to borrow money has already done so and another 15 basis points off the cash rate will make no difference. So, in the eyes of many, the RBA has “run out of ammo” and the only option left on the table was QE. Lowe said in a recent speech that he held off cutting rates earlier in the crisis because the shutdown of the economy made it unlikely that enough would-be borrowers could have taken advantage. But he now thinks it might have more leverage.
Will it devalue the dollar?
For sure. In fact, forcing down the dollar is one of the unspoken aims of the QE program. Most other western economies have become hooked on the QE medicine since the global financial crisis. When the Bank of England started the scheme in the GFC, it racked up £375bn (A$750bn) over three years before it stopped in late 2012. The US Federal Reserve reached US$4.5tn in its first five years. The effect, over time, has been to drive down their currencies, making the Aussie dollar seem relatively overvalued and making Australian goods more expensive overseas. The chatter about QE in recent weeks and signalling from the RBA has seen the Aussie dip to a two-month low of just above US70c.
Does any of this work?
QE was widely regarded as having saved the world economy from collapse back in the GFC . Although the schemes were being phased out, the pandemic revived the spirit of 2008 among central bankers who unleashed a torrent of new money to help maintain confidence. The US Federal Reserve is the lead player and wasted no time in spluging hundreds of billions of dollars to buy up government-backed debt when the pandemic struck in March. The net result is that, so far, the global economy has stayed on its feet.
Sounds too good to be true. What’s the downside?
That’s right. Many people have warned for years that QE should have been wrapped up years ago. It was only ever intended as an emergency measure but, with markets flooded for a decade with the cheapest money of all time, the world economy has effectively doubled down on the debt addiction that caused the GFC in the first place. By keeping QE going for so long – and by keeping rates so low for so long – central banks have been left with no other policy to tackle the current crisis. This has been compounded by the refusal of governments to pump-prime economies with fiscal stimulus, leaving the RBA and others to do all the heavy lifting.
