The Reserve Bank of Australia (RBA) recently disclosed that it has road tested options for quantitative easing (QE), the term used to describe the unconventional policy tools central banks can deploy once interest rates, the conventional tool, approach zero. QE has been underway in the US, Japan, Europe and the UK for some years as a means of fighting the deflationary effects of “the great recession” of 2008-09, but has not yet been used by the RBA.
The chance of QE being deployed in Australia is “very remote”, according to the RBA. Indeed, the RBA’s recent revelation does not mean the bank is seriously contemplating QE, or what some call “helicopter money”, a term coined by economist Milton Friedman, where anxious policy makers sprinkle central bank generated cash upon grateful citizens, as if from above.
It should be noted that the RBA still has plenty of conventional policy ammunition to deploy before resorting to QE, even after the recent rate cuts. The cash rate is at a record low, but can be lowered further. Futures market pricing implies the RBA will cut the cash rate at least one more time, but few reputable economists expect the bank to embark on QE any time soon.
Indeed, RBA officials have said the in-house analysis of QE is not a plan, merely a contingency in case things go horribly wrong and the bank has exhausted its conventional options. It is entirely proper and appropriate that the bank does such analysis, so officials are prepared should unexpected circumstances emerge.
In theory, these unconventional policies are designed to achieve a number of primary goals. One method, where central banks buy government bonds, aims to keep long-term interest rates low, which in turn acts to keep market interest rates lower than otherwise. This has obvious benefits for economic growth, and the additional liquidity in bond markets can enhance financial stability. Hopefully, inflation pressures build, encouraging production and spending.
We have tried a form of helicopter money before, to good effect, albeit in the form of fiscal, rather than monetary policy. As recently as the global financial crisis in 2008-09, the government distributed cash benefits directly to households to encourage spending. This helped keep the economy from dipping into recession, alongside the RBA’s aggressive rate cuts, the precipitous fall in the Australian dollar (AUD) and massive stimulus in China, which lifted demand for our commodity exports.
It is not clear though, that a round of unconventional monetary policy in Australia would work in the same way, or to the same extent, that it has elsewhere. Australia’s interest rate structure differs from the US’, with mortgage rates here tied more to the cash rate, than the bond rate. QE here, then, may not keep mortgage interest rates low after all. There are also other complications, like the small size of Australia’s bond market.
The flipside is that conventional policy tends to work better here than in the US.
With unconventional QE only a distant possibility, perhaps a more pertinent question to ask is: why have low interest rates not had a bigger impact? The RBA has been cutting interest rates since late 2011, yet growth in the Australian economy remains lacklustre, and inflation is below the RBA’s 2–3 per cent target.
In answering this question, we don’t know what would have happened had the RBA not eased monetary policy as assertively as it has. Economic conditions would almost certainly have been worse, but there is a perception that cuts to interest rates have lost some of their traction – they do not get the same economic bang for their buck. Why?
One explanation could be that the cost of capital is not the problem. A lack of what RBA governor Stevens calls “animal spirits” means many firms are unwilling to invest and hire no matter the interest rate. Also, local banks have not been passing on the RBA’s rate cuts in full, dulling their impact. Finally, the AUD has fallen since 2012, though not by as much as policy makers had hoped, partly owing to aggressive QE elsewhere.
For now, despite diminishing returns on conventional policy, the RBA will continue to lower the cash rate as necessary, which should help weaken the AUD. The unconventional tools, including QE, will remain locked away but are ready to be deployed if needed.