April 09, 2020 05:00:00
Earlier this week I wrote about the Reserve Bank’s decision to start printing money.
Yes, Australia’s central bank is now plugging in extra digits on its computer trading screens to artificially pump-up how much cash it has on its balance sheet.
It’s creating money out of thin air. It doesn’t need to print the money via the Mint.
It’s doing this so it can dive into the bond market and buy up as many government bonds as it so chooses.
The idea being that the more bonds it buys up, the lower interest rates go, and the easier it is for people to repay their mortgages, for businesses to pay off their loans and for the government to afford its JobKeeper payments.
Once the piece was published though, I received a flood of emails, texts and calls with follow-up questions.
Why? Well because this is stuff is not easy to wrap your head around. I mean what are bonds in the first place, who owns what? Why can’t the Reserve Bank just write off the debt?
So, here are some answers to the most common questions.
What are bonds?
They are IOUs. If you earn money, you have the capacity to borrow money and pay it back at some point, with interest.
The government can borrow huge amounts of money because it has a big capacity to pay it back — because it’s got millions of taxpayers giving it money every day.
So, it issues its own bonds (with a world-class credit rating attached).
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Is there a limit to how much money the RBA can create?
Theoretically there are no limits to how much the RBA can increase the size of its cash reserves by creating money our of thin air (or the tap of a keyboard).
The Reserve Bank will create as much money as it believes is necessary to stabilise the monetary system and to ensure the government, households and businesses can borrow with relative ease.
To ensure the credibility of the RBA itself though, and the integrity of the monetary system as a whole, the Reserve Bank will only print money, and buy bonds, to assist with sound economic policy.
Even in its latest monetary policy statement it made it clear the bank was already working on a money printing exit strategy.
“Bank has bought around $36 billion of government bonds in secondary markets, including bonds issued by the states and territories,” RBA governor Philip Lowe noted.
“The Bank will continue to promote the smooth functioning of these important markets.
“If conditions continue to improve, though, it is likely that smaller and less frequent purchases of government bonds will be required.”
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For how long can it occur?
There are no hard and fast rules around how long quantitative easing or money printing should last.
In the United States it lasted years during and after the global financial crisis. In Japan, it lasted over a decade.
“It could go on indefinitely,” AMP Capital’s Head of Investment Strategy Shane Oliver told the ABC.
Doesn’t money printing lead to hyperinflation?
Hyperinflation is when prices for everyday items spiral out of control.
It’s been known to happen when money printing is involved.
Economists say it’s unlikely to happen this time around, in Australia, because inflation was already very low to begin with.
“The downside [to QE] is that it could cause inflation,” AMP Capital’s chief economist Shane Oliver says.
“It’s made possible now because inflation is low.”
In addition to this, the global financial crisis left the global economy with a legacy of relatively high underemployment, the gig economy, and very weak wage growth.
“GFC left a lot of spare capacity in labour markets,” Dr Oliver says.
So basically all of this points to the fact that, in this economic climate, strong inflation is hard to come by, so even a $36 billion money printing program by the RBA is unlikely to change that.
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Doesn’t it have to be ‘paid back’ at some point?
This is a hugely important question, and the answer is yes.
First let’s look at why the RBA is buying bonds directly from the government.
By far and away the most frequently asked question was, “why can’t the Reserve Bank just buy the bonds directly from the government?”
If the Reserve Bank did this it would be directly providing the government with money it’s plucked out of thin air, which the government can then spend or give to households.
The famous economist Milton Friedman came up with this idea in 1969. To illustrate it he described a helicopter dropping money into people’s backyards.
But the RBA and government are doing this! I hear you say.
Well, sort of.
The government issues bonds, banks buy those bond and the Reserve Bank then buys those same bonds off the bank. So, for practical purposes, the RBA now owns those bonds and will receive coupon payments from the government … and you could draw a line from the RBA to the government in terms of money flows.
The government then uses that money to pay for JobKeeper payments and the like — money directly into workers’ pockets.
That sounds an awful lot like helicopter money.
However, by putting the private sector between the government and the Reserve Bank, you create a crucial buffer.
It means the Reserve Bank can’t simply write off the debt (which would compromise the integrity of the entire monetary system). It’s not even tempted to do that.
In addition, by ensuring the bonds make it into the private financial markets, the Reserve Bank can influence interest rates across the board (because changes in the three-year bond yield have a knack of influencing other interest rates).
Leading economists conceded it’s helicopter money by a different name.
“It is a technicality,” concedes Dr Oliver. “It’s a fine line.”
EY Oceania’s chief economist Jo masters agrees.
“It is quite a fine line. If you get a central bank buying bonds directly from the government, you blur the lines of [independence].”
By having the Reserve Bank buy bonds in the secondary market, “it adds another step in the process that keeps the elected government focused on fiscal policy,” Ms Masters argues.
Take heart, this is a mathematical description of one aspect of a central bank how buying bonds helps the economy.
I’ve no idea what it means.
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