Below zero is "inverse". How the Reserve Bank would make quantitative easing work

With its official exchange rate expected to fall below the 1% mark to reach a new, extremely low level close to zero, all kinds of people say the Reserve Bank risks "running out of ammo." Ammunition might be needed if the last financial crisis it has to reduce rates by several percentage points.

This view badumes that when the cash rate reaches zero, the Reserve Bank can do nothing.

The view is not only wrong, but also dangerous, because taking it seriously would mean that all future rounds of stimulus should come from a fiscal policy (spending and taxation), even if fiscal policy is probably inefficient in the long run. term, its effects being neutralized by a floating exchange rate.

The experience of the United States shows that the Australian Reserve Bank could very easily take measures that would have the same effect as reducing its cash rate by an additional 2.5 percentage points, that is 2, 5 percentage points below zero.

Reserve bank rate since 1990

In a report published Tuesday by the US Center for American Studies at the University of Sydney, I document the successes and failures of the American approach of quantitative easing (QE) between 2009 and 2014.

This shows that it is always possible to change the instrument of monetary policy, moving from the official interest rate changes to those of other interest rates, by buying and selling by holding other financial instruments such as long-term government and corporate bonds.

The more the Reserve Bank buys these bonds from private sector owners, the lower the long-term interest rates needed to place them, and the older owners whose cash-laden resources are forced to invest. 39 to serve.

In the United States, the Federal Reserve also used "forward-looking forecasts" on the likely future course of the US federal funds rate to convince markets that the rate would be kept low for a long time.

It's hard to know which mechanism was the most powerful, or whether the Fed even needed to buy bonds to advance the forecasts. However, in a stressed economic environment, it is worth it to try both.

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The Reserve Bank will lower rates again and again, until we increase spending and raise prices

As interest rates are expected to remain low for a long time, the exchange rate will fall, making it easier for Australian companies to borrow from abroad, export and compete with imports.

According to the scientific literature, QE has reduced long-term interest rates by about one percentage point and has economic effects equivalent to a 2.5 percentage point reduction in the US federal fund rate. after he was close to zero.

QE does not need limits …

According to US estimates, the Australian Reserve Bank should purchase badets equivalent to approximately 1.5% of its Gross Domestic Product to the equivalent of a 0.25 percentage point reduction in the official cash rate. . That's about 30 billion Australian dollars.

With more than $ 780 billion in long-term securities issued by governments (the states and the Commonwealth), there is enough to host a very large procurement program with the Reserve, and the bank could also follow suit from the Fed and extend the scope of purchases to include non-government securities, including mortgage-backed securities.

He could also learn from American mistakes. The Fed has been slow to reduce its official interest rate to a near-zero level and to embark on QE in the aftermath of the 2008 financial crisis. Its first attempt was limited in size and duration. Its success in using QE to stimulate the economy must be considered the lower limit of what is possible.

… even though he's becoming less effective as he grows up

He has often suggested (although it is absolutely not certain) that monetary policy becomes less effective when interest rates become very low, but this is not necessarily an argument for using less monetary policy. This could just as well be an argument for using it more.

Since there is no principled limit to the amount of QE that a central bank can do, it is still possible to do more and succeed in raising the rate of inflation and spending .

Fiscal policy may be even less effective. To the extent that it succeeds, it is likely to push up the Australian dollar, making Australian companies less competitive.

The US economist Scott Sumner estimates that the additional gain from public spending or tax cuts (known as the multiplier) is close to zero.

The Governor of the Reserve Bank, Philip Lowe, this month launched a call for help from the government itself, asking for additional infrastructure spending and measures to increase productivity growth.

Read more:
Vital signs. If we fall into a recession (and we could), we will have to go after ourselves.

He is right to identify the contribution that other policies can make to economic growth. Nobody seriously believes that Reserve Bank monetary policy can or should replace productivity growth.

But it's a good, perhaps a very good substitute for government spending that does not contribute to productivity growth.

Three myths about quantitative easing

In the paper, I discuss several myths about EQ. The first is that it's about printing money. It does not print more money than does conventional monetary policy. It pushes money into the hands of the private sector by adjusting interest rates, although their rates are different.

Another myth is that it promotes inequality by helping the rich to enrich themselves.

It's a widespread myth. Former Coalition Treasurer, Joe Hockey, told the British Institute of Economic Affairs in 2014 that:

Flexible monetary policy actually helps the rich to enrich themselves. Why? Because we have seen an increase in badet values. The richest people own the badets.

But this does not increase the inequality of conventional monetary policy and can not even widen them at all if they manage to maintain sustainable economic growth.

A third myth is that it leads to excessive inflation or socialism.

In the United States, the inflation rate is among the lowest since the second world war. Nowadays, central banks are more inclined to create too little inflation than too much.

Some have argued that QE in the United States is at the root of the rise of leftist populists
like Alexandra Ocasio-Cortez and "Millennial Socialism". But it is probably more true to say that their grievances stemmed from excessive tightening rather than a loss of monetary policy.

QE has been tested on the road. We have little to fear, just as we have not had to worry about conventional monetary policy.