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When printing even $100b is not enough

Overly cautious politicians and bankers are forcing the Reserve Bank to look at even more extreme ways to stimulate our Covid-hit economy and revive inflation, Bernard Hickey writes

The Reserve Bank announced much more stimulus than everyone expected this week, but even this much was not enough to move the inflation needle, or get the public's attention.

The Bank detailed how it's looking at easing again later this year and early next year, partly because the Government is not borrowing and spending enough in its own right, and partly because banks have pulled back from new lending to businesses. The new more extreme measures could include the RBNZ helping banks by lending its own money cheaply to banks at zero percent while cutting the official rate to negative levels, and printing money to buy bonds overseas.

Yet these extreme measures were barely noticed in public, let alone debated.

It seems extraordinary to write this, but the Reserve Bank's announcement on Wednesday afternoon it would expand its Quantitative Easing or money printing programme from $60 billion to $100b struggled to get anywhere near the top of news bulletins or news website home pages. Even a year ago, this was an unthinkable step for our Reserve Bank to take, but it barely made into the first 20 minutes of the most-watched news programme on a day our largest city was roadblocked at both ends and politicians debated whether the September 19 election should be delayed.

Former Green Co-Leader Russel Norman was ridiculed by the then National Government eight years ago for even suggesting money printing, but this week the $100 billion announcement wasn't even mentioned by any colour of politicians, let alone debated.

Even at the beginning of this year, no one would have seriously suggested that within a space of five months the Reserve Bank would have been forced to slash the Official Cash Rate to almost zero percent, announced a 'big bazooka' of a $30b QE programme, increased the bazooka to $60 billion, and then went beyond even the most aggressive forecasts to lift it to $100b. Many economists were still well behind the curve, with just one (Kiwibank's Jarrod Kerr) forecasting a rise to $100b and most grouped around a rise to $80b.

So why so much?

The Reserve Bank's main job is to keep annual inflation between around two percent over the longer run, but the global deflationary pressures dragging on prices before Covid-19 have been amplified by the crisis. It means not only is inflation below two percent (it was 1.5 percent in the June quarter), but expectations of inflation are dropping too. The Reserve Bank's Monetary Policy Committee particularly noted a "risk that persistent low inflation and employment become embedded in people’s expectations, creating the need for more monetary stimulus than otherwise."

If people think prices and wages are going to fall, that can turn into a spiral downwards as consumers wait for prices to fall and hold off spending because they want a better deal at lower prices and are worried their wages will fall. That change in expectations can be enough to slow spending and the economy more generally. It can turn into a vicious cycle, forcing the Reserve Bank to stimulate even harder to reverse the cycle. 

The central bank's current weapon of choice is money printing, which is done by buying Government bonds. The problem for the bank is that it is reaching the limits of how much it can buy without hoovering up so many bonds that the market stops operating. 

Will there be enough bonds to buy?

Before announcing the rise in its bond buying to $100b, the bank had to ask permission from Finance Minister Grant Robertson to increase the percentage of bonds on issue it could buy. Previously the Reserve Bank said it could not buy more than 50 percent of the bonds on issue before affecting the market's ability to operate. But in this decision, it said its experience with bond buying since starting in March is that the market can handle a higher proportion. It asked Robertson for approval to go to 60 percent and he granted it.

The problem is the Government is not borrowing enough, or fast enough for the Reserve Bank to use this tool. The Reserve Bank's aim is to 'front-load' its buying of up to $100b within the period to June 2022, but the Government's current forecast is to have only issued $130b of bonds by the middle of next year. 

The Government's decision on July 20 to 'set aside' $14b of its $50b Covid-fighting fund set up in the May Budget indicated the Government was taking a fiscally conservative approach. That was confirmed last week when Prime Minister Jacinda Ardern said the fiscal position was 'tight' and she committed to the existing debt track as Labour's effective debt target. That limits the ability of the Reserve Bank to use bond buying to lower interest rates. Opposition Finance Spokesman Paul Goldsmith has even said he wants to reduce net debt from a peak of 54 percent of GDP in 2023 to 30 percent of GDP by 2030, which implies an austerity programme that removes the Reserve Bank's bond buying ammunition completely.

So what else can it do?

The Reserve Bank introduced a lot more detail this week about creating a 'Funding for Lending Programme' (FLP), which would see the Reserve Bank cut the Official Cash Rate to negative levels and then lend its own money to banks at around zero percent so they could cut interest rates.

The fear of the banks and the Reserve Bank is that moving to negative official rates without such a programme would effectively freeze the banks' lending appetites in the headlights of negative rates. Negative interest rates reduce bank profits and make it very difficult to get cheap funding from their own term depositors because it's widely seen households would simply refuse to put their money with the banks if they were 'charged' negative rates to do it.

So this is effectively the Reserve Bank helping the banks with cheap lending that encourages them to lend out to households and businesses. The Reserve Bank admitted this week it was effectively a subsidy for banks and would open the central bank up to risks around future interest rate changes (because it is lending long-term to banks at around zero percent and the banks are lending out at shorter terms) and around credit quality (because the Reserve Bank will want collateral from banks to secure the lending.)

It was clear from the Governor Adrian Orr's commentary and comments by Robertson in his letter of approval about looking at alternative tools. "I support the Reserve Bank's intention to become operationally ready for FLP and to begin consultations with relevant parties," Robertson wrote.

Why won't the banks lend to businesses?

One reason for the need for yet more stimulus is that the Reserve Bank pointed out banks are not making brand new loans to businesses, and in many cases had actually tightened their lending standards this year. Perversely, some business lenders borrowers may even have seen their interest rates increased as banks increased their margins to base rates to account for weaker collateral and higher risks. The Reserve Bank isn't sure about this so is collecting more data. (Corrected lenders to borrowers)

The irony of all this action is that all of the Government's borrowing is now being funded indirectly through financial markets by the Reserve Bank, which is helping lower wholesale interest rates. That in turn is being passed on to home owners, but not necessarily businesses. 

More bond buying will encourage more lending against housing, and a Funding for Lending Programme, would accelerate that.

In the absence of significantly more housing supply, that will fuel yet another surge in house prices. It has already stopped the fall many had expected back in March.

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