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Will RBNZ QE help bridge the gap and how does it work?

Hamish Pepper web
Hamish Pepper | Posted on May 6, 2020

What is the Reserve Bank of New Zealand’s (RBNZ’s) Quantitative Easing (QE) programme?

After cutting the Official Cash Rate (OCR) by 75bp to 0.25% on March 16th, the RBNZ launched its Large Scale Asset Purchase (LSAP), or QE programme, just one week later.  LSAP has a target to buy $30bn of government bonds over the next year; equivalent to 10% of Gross Domestic Product (GDP) and, at the time, almost 50% of outstanding bonds making it a large programme by global standards. The RBNZ also recently announced that it would buy $3bn of Local Government Funding Agency (LGFA) bonds, representing about 30% of outstanding bonds.

What is the RBNZ trying to achieve?

COVID-19 containment measures have dramatically reduced economic activity and, with conventional policy (i.e. OCR cuts) reaching its limit, QE can provide additional help by lowering long-term interest rates, weakening the exchange rate and, in some cases, improving market liquidity.

How much of this can RBNZ do?

The RBNZ has recently noted that, from global experience, buying 40-50% of outstanding bonds is the limit. Beyond this, disruption to market functioning may occur. Additional fiscal stimulus in New Zealand, and the associated higher pace of bond issuance, will likely see the government bond market grow to a larger size than the RBNZ initially estimated – allowing the QE programme to be expanded by as much as $30bn.

But where does the money come from to pay for the bonds?

The money is digitally ‘printed’, with the RBNZ creating additional reserves, increasing the money supply and the size of its balance sheet. Effectively, the RBNZ buys government bonds or other bonds in the market, and “pays” for those by adding digital money to the relevant bank or financial institution settlement account with the RBNZ.

Isn’t that inflationary?

Perhaps in the medium-term, but that is exactly what is needed right now given the large amount of excess economic capacity and associated disinflationary pressure that COVID-19 lockdowns here and globally have created. New Zealand’s unemployment rate, for example, is likely to more than double, reaching close to 10%.

What stops inflation taking off?

When the economic environment eventually improves, the RBNZ can sell bonds or allow them to mature, most likely placing upward pressure on interest rates, and downward pressure on inflation. Once the RBNZ’s balance sheet has normalised, i.e. it holds no more bonds, it can use OCR increases to help keep inflation contained.

Is this also about funding the big increase in government spending?

QE is undoubtedly helping to absorb the increased government bond issuance, but the primary purpose of the QE programme is to lower interest rates. Without the RBNZ buying government bonds as part of its QE programme, government bond yields and interest rates that are sensitive or benchmarked to those would be significantly higher. The Government has so far announced $22bn of stimulus (spending and tax relief) in response to COVID-19, and the New Zealand Debt Management Office increased its 2019/20 issuance programme by $15bn, to $25bn. We expect another $20bn of government stimulus to be announced imminently, and next year’s issuance to be c.$45bn ($35bn net).

This sounds like that Modern Monetary Theory (MMT) concept I’ve heard about, is that what’s going on?

Not quite, but close. MMT is where central banks print money with the objective of financing government expenditure, rather than buying government bonds in the secondary market to lower interest rates. The theory is that, for countries with their own currency, this can be done in an unlimited way (permanently expanding the money supply) with inflation the only constraint. Under MMT, there is essentially no debt to be repaid.

Is QE also different to “helicopter money”?

Yes. Helicopter money usually refers to a permanent expansion to central bank reserves via direct transfers to households – i.e. the money supply is permanently larger. It is usually discussed as an option when QE has failed, given the significant inflationary risks.

Wait a second, all of this government bond issuance that the RBNZ is helping to digest, isn’t that going to significantly increase our debt burden?

Yes. Government debt to GDP is likely to increase from 20% to 50% over the next few years. But this is low by global standards (OECD average is c.100%). Previous governments have managed the economy to ensure we have the capacity to absorb large economic shocks.

Ok, our government debt burden remains low by global standards, but we still need to service this additional debt, how will that work?

It’s most likely to come over time via increased taxes and reduced government spending. However, very low debt servicing costs should allow time for the economy to recover before this is necessary. For example, the highest yield on a New Zealand government bond is currently around 0.95% for the bond that matures in 2037.

How will foreign investors in the New Zealand market feel? Don’t we rely a lot on foreign funding?

Yes, that remains a vulnerability for New Zealand as a whole. New Zealand household debt is c.165% of GDP and mostly comprises mortgages, a portion of which are funded offshore.  As a country, we owe the rest of the world 55% of our GDP. Within government bonds, foreigners own about 50% of them. As such, it’s important that these investors continue to have faith in New Zealand’s fiscal discipline and the independence of our institutions.

How strong are New Zealand’s institutions?

New Zealand’s institutions are held in high regard. We have an independent central bank, with a long record of targeting inflation, and a strong debt servicing history which supports us as a reputable borrower. This is best captured in the 2 April 2020 ratings review by Moody’s, who noted the following when affirming New Zealand’s Aaa rating and stable outlook:

“The drivers behind the rating affirmation include Moody's assessment of New Zealand's strong governance, including sound monetary and fiscal institutions with track records of proactive and effective policymaking.”

Surely QE carries some risks though?

It does and using this new tool in large size requires caution. We are learning about its effects and the prospects for error are higher than with conventional monetary policy. If used excessively, it may result in dangerously high inflation, and if used too cautiously, inflation could be dangerously low. Both circumstances could have persistent effects via a de-anchoring of inflation expectations. We have a great starting point, however, with the ability to draw on overseas QE experience given several countries have been using QE since the Global Financial Crisis (GFC), low government debt levels and strong institutions.

But QE has not really worked in Japan and Europe, has it? Don’t they just keep adding to debt and expanding QE programmes to cope with this?

Both have government debt levels that are much higher than before the GFC and have generally struggled to generate sufficient growth to reduce these meaningfully. The eurozone has had the greatest success, dropping government debt from 93% of GDP in 2014 to 84% by the end of 2019, but that’s still well above the 66% registered in 2007. Some also argue that very low interest rates have enabled inefficient ‘zombie’ companies to survive, which constrains dynamism and growth. While this may be true, the US and UK have had more favourable QE experiences and it is generally accepted that, without QE, Japan and Europe would have suffered sharper economic declines, imposing harsher social costs.

What else might be needed to help the economy recover?

QE is just one part of the toolkit. It prevents the economy from being choked by sharply higher interest rates. Negative interest rates are another option that the RBNZ has said it is open to, but the efficacy of these is questionable and they carry financial stability risks. Other tools include well-targeted, clear and consistent government policy and spending.  

The key to New Zealand’s long-term prosperity lies in strengthening our education system, learning from COVID-19 and investing broadly in our healthcare sector, embracing innovation, sustainable investing and digitisation. Governments should aim to continue with microeconomic reforms that reduce costs, improve efficiency and prevent unhelpful behaviour.


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