Lunatic RBA on QE options

Via the Lunatic RBA’s recent appearance in Parliament:

It’s possible that we end up at the zero lower bound [for the cash rate]. I think it’s unlikely, but it is possible. We are prepared to do unconventional things if the circumstances warranted it. I hope we can avoid that. So what are the unconventional options?

When we look overseas, we see some central banks have very low interest rates and some countries have negative interest rates…That’s one possibility.

Another thing that central banks have done is give very explicit forward guidance that they’re not going to move interest rates until some time has passed or until some certain conditions are met.

We’ve also seen some central banks support credit creation in their economies. – There’s a particular case in Europe where banks didn’t want to lend. The European Central Bank has provided funding to the banks that is cheaper than the market rate, on the condition that they lend. – We’ve seen some central banks expand their balance sheets very greatly by buying government securities in the effort to try and get the risk-free yield curve down. We’ve seen other central banks buy other assets, mortgage backed securities and corporate bonds. The Bank of Japan has bought equities. – The other thing we’ve seen in just a couple of cases is foreign exchange intervention. Switzerland is the best example of that. Their currency was under strong upward pressure and they put a cap on it. This is the range of things that we’ve seen overseas.

I’m not thinking that any or all of those would be appropriate in Australia. There are some lessons, though, that we’ve drawn. The effectiveness of these measures depends upon the specific circumstances the country’s in and the nature of its financial markets. There’s not a one-size-fits-all here. There are 4 lessons to draw when assessing different circumstances: – These measures have had clear success in dealing with dislocation and credit supply in the economy. – They’ve also had success in lowering government bond yields, which is a risk-free rate, and therefore they’ve had success in lowering interest rates across the economy for private borrowers as well. – A package of measures works best—rather than doing just one thing, doing a number of things that reinforce one another. – Clear and consistent communication is really important.

How we would apply those lessons to Australia would really depend upon the particular circumstances that we’re in. I think the focus would be on trying to reduce the riskfree interest rate. We could reduce the cash rate down to a very low level, and it’s possible, if the circumstances warrant it, that we could take action to lower the riskfree rates further out along the term spectrum.

If we’re talking about QE as being the central bank purchasing government securities— which I think in the Australian context is the most likely form it would take—in principle, we could do that at any level of interest rate and principal …. [However] We’ve got scope to lower interest rates at least a couple more times, using conventional monetary policy. Beyond that, … I’d hope we were getting some fiscal support as well and support through the other mechanisms that I talked about.

In talking about this, I want to make it clear that this is quite a long way from the central scenario. I think it’s unlikely; it is possible, and it’s prudent for us to be prepared.

They’d be better off targeting real rate spreads than the risk free rate which will be cratered anyway. It doesn’t bode very well for their efforts. Or, perhaps, they’re deliberately misleading parliament to avoid blowback.

Who knows! Nobody ever accused the Lunatic RBA of being quick off the mark.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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