Australia Is Finally Debating QE, Even If Its Central Bank Isn't
(Bloomberg) -- The prospect of interest rates going below 1% has prompted Australia’s economists to start exploring what much of the developed world has already contended with: the introduction of unconventional monetary policy.
While the Reserve Bank is unlikely to embark on quantitative easing for now simply to accelerate inflation and support hiring, a consensus is forming about when it would. Should a serious shock occur -- most likely from offshore and probably China -- that drives up the jobless rate and threatens recession, the central bank will then need to look elsewhere for ammunition.
“If the global outlook worsens sharply from the trade war, we see the RBA feeling the need to get ahead of a potential slowing in the global economy and provide additional stimulus,” said Hayden Dimes, an economist at Australia & New Zealand Banking Group Ltd. “With the cash rate rapidly closing on its likely lower bound, this would almost inevitably need to be quantitative easing.”
Voracious demand from China for resources helped Australia motor through the 2009 global recession, with the cash rate only dropping to 3% before the RBA started tightening toward the end of that year. Australia’s escape from contraction and avoidance of the lower bound allowed policy makers to study how unorthodox policy played out globally -- from bond buying to negative rates to forward guidance -- and draw conclusions on how to apply it.
Governor Philip Lowe has said he doesn’t regard QE as a serious option in the central bank’s current easing cycle. When reiterating last week that rates were likely to head lower again, after the RBA cut to 1.25% earlier in June, he said policy was unlikely to follow the path of overseas peers because the central scenario for Australia’s economy was still “quite reasonable.”
“I am very hopeful that we will not need to go, certainly into negative territory, or to these very low interest rates that the Federal Reserve and the Bank of Canada got to,” Lowe said in a Q&A session following a speech in Adelaide, citing those central banks’ 0.25-0.5% rates in the past.
RBA No. 2 Guy Debelle has already painted a picture of how QE might look in Australia, in a December speech marking a decade since the global financial crisis. He also defended its use in extreme circumstances during the central bank’s semi-annual testimony before lawmakers in February. Based on his comments, the following lessons apply:
There are less government bonds in Australia, which may make QE more effective because the bank wouldn’t need to buy as many bonds to bring down yields. However, most of the traction in borrowing rates Down Under is at the short end of the curve, which might reduce the effectiveness of QE because in other markets it has been designed to bring down yields on longer-dated securitiesThe RBA’s balance sheet can also expand to help reduce upward pressure on funding, as occurred in 2008 when it provided cheap funding to banks. The U.S. experience suggests the RBA would need to buy securities equivalent to 1.5% of GDP to achieve the same effect as a 25 basis-point rate cut, according to Stephen Kirchner, an economist at the United States Studies Centre in SydneyThe floating exchange rate remains an important shock absorber
Veteran economist Saul Eslake, who studied the options for QE several years ago, reckons the floating currency is Australia’s key advantage. Policies that lead to a lower local dollar would be the best option because Australia isn’t a globally significant exporter of manufactured goods, and so efforts to encourage a depreciation shouldn’t draw the level of opposition that others would, he says.
QE could work if implemented decisively and in an unlimited commitment, says Kirchner. He argues Australia could implement a smaller but more effective program than the Federal Reserve, which bought assets equivalent to 29% of GDP in the five years through 2014, his research shows.
“If necessary, the RBA should transition quickly from a cash rate target to large and open-ended purchases of government bonds,” as well as non-government and non-debt securities, Kirchner said in a report last week. “These purchases should be tied to achieving explicit macroeconomic objectives, in particular, maintaining the stability of nominal spending.”
The view from the continent, where the European Central Bank and Bank of England have run unorthodox policies, is that Australia’s challenges are very different to those institutions, according to Bill Evans, chief economist at Westpac Banking Corp., after speaking with bankers there. There are always unintended consequences and costs, he cited them as saying.
“Such a policy should only be adopted when a credit crisis has emerged,” Evans said. “It should not be adopted as a form of stimulus,” particularly when that mainly involves trying to push unemployment down to a level that fuels faster inflation.
--With assistance from Garfield Reynolds.
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