5 ways the Reserve Bank is going to bat for Australia like never before



Olga Kashubin/Shutterstock

Peter Martin, Crawford School of Public Policy, Australian National University

The most important of the five measures the Reserve Bank announced on Tuesday is the one that won’t whirr into place for a very long time.

Others start immediately. On Thursday the bank will wade into the market and start buying up bonds issued by Australian governments.

It’ll buy Commonwealth government bonds with five to seven years left to run on Mondays, Commonwealth bonds with seven to ten years left to run on Thursdays, and bonds issued by state governments on Wednesdays.

It’ll spend about A$5 billion a week, every week for six months until it has unloaded $100 billion.

1. $5 billion per week, week in, week out

As before, when it did this on a more limited scale, it won’t be buying the bonds from the governments that issued them, but from third parties such as super funds and investment managers.

What’s (very) different is that it will be forcing a particular sum of money into their hands.

Its earlier bond buying program (which will continue) spent only as much as was needed to achieve an interest rate target.

The new program will spend a particular sum of created money (the Reserve Bank creates it out of nothing) every week for six months, whatever happens to rates.




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The government has just sold $15 billion of 31-year bonds. But what actually is a bond?


It’ll be true “quantitative easing”, in that it’s the quantity of money that will matter, not the price.

Once in the hands of investors who would really rather own bonds, they’ll have to do something with it, such as investing in a business that employs people. That’s the theory.

As well, with bonds harder to find in Australia, fewer foreigners will move money here to buy them propping up the Australian dollar. That should allow the Australian dollar to fall, making local businesses more competitive against those from overseas. That’s the other part of the theory.

2. Cash rate near zero

And that’s just one of five measures Reserve Bank Governor Philip Lowe announced on Tuesday.

The once-watched cash rate which is the interest rate on unsecured overnight loans between banks, was cut to 0.25% in March amid hope that 0.25% was so low it wouldn’t need to be cut further.

Within days the actual cash rate at which banks transact business had fallen a good deal lower because, at 0.25%, many more of them wanted to lend than borrow.


Target cash rate versus actual


Reserve Bank of Australia

When it settled at about 0.14% the Reserve Bank didn’t bother to intervene to push it back up.

The new target of 0.10% will give banks almost no return for lending to each other and make borrowing from each other almost costless.

The separate rate for cash on deposit with the Reserve Bank will fall from 0.10% to as good as zero, 0.01%




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More than a rate cut: behind the Reserve Bank’s three point plan


If the cuts were passed on in full to bank customers they would cut the standard variable mortgage rate from around 3.2% to 3%.

The rate on new mortgages would slide from 2.7% to 2.5%. The rates on customer’s deposits, already near zero, would fall further.

3. Bond rate to 0.10%

The Reserve Bank had been targeting a three-year bond rate of 0.25%, buying as many bonds as were needed to keep it there. It’ll cut that target to 0.10% in line with its cut in the cash rate, buying as many bonds as are needed to get and keep the rate at 0.10%.

Three-year bonds are used to fund fixed three-year mortgages and personal and business loans. All will become even cheaper.

This bond-buying program, which will target the rate, is completely separate from, and additional to, the $5 billion per week the bank will spend buying longer-term bonds week in, week out.

4. Near-free loans to banks

Since March the government has been advancing money to private banks for three years for just 0.25%.

The more they expand their lending to business (and especially to small and medium sized business) the more it will it will advance them in accordance with a formula.

The formula won’t change but the rate will. From Thursday new loans under the program will be offered to banks for just 0.10%.

5. A commitment with teeth

Until now, the bank has been fuzzy about the circumstances in which it will eventually change course and start pushing rates back up.

Its commitment was weaker than it sounded

the board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band

Whether or not “progress is being made” is subjective.

The commitment allowed the bank to assert that progress was being made and reverse course at its convenience.

Whether or not the bank was “confident” that inflation would be sustainably within its target band was even more subjective.

One word, big change

Reserve Bank Governor Lowe on Tuesday.

On Tuesday, Governor Philip Lowe ditched the fuzziness and replaced it with something measurable.

The board will not increase the cash rate until “actual inflation” is sustainably within the 2% to 3% target range.

“For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market.”

So prepared is the bank to bat for Australia that it won’t stop until there’s a “tight labour market”.

And it has used the word “actual”.

No longer will the bank need to merely see “progress towards” an inflation rate of 2% to 3%. It will have to be faced with an “actual” inflation rate of 2% to 3%.

Low rates for a long, long time

Australia’s inflation rate hasn’t been sustainably between 2% and 3% for more than half a decade, and it is likely to be at least that long again until it gets back there, if ever.

Governor Lowe said the bank’s forecasts, to be published this Friday, will put the inflation rate at 1%. It’ll put wage growth at the lowest on record, less than 2%.

By tying the future of the cash rate to an actual inflation rate rather than a feeling about the inflation rate, Governor Lowe is tying the bank to a cash rate of close to zero for as far anyone can see.

It means that not only will it be as cheap as it has ever been to borrow (for a mortgage, a business, for anything) it means there’s no risk of that suddenly changing because the bank gets rush of blood to the head.

It’s about the future, but it matters now.The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Keating is right. The Reserve Bank should do more. It needs to aim for more inflation



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Chris Edmond, University of Melbourne and Bruce Preston, University of Melbourne

Former prime minister Paul Keating isn’t alone in wanting the Reserve Bank to do much more to ensure economic recovery.

In an opinion piece for major newspapers he has said it ought to be directly funding government spending rather than indirectly by buying government bonds from third parties.

But we think there’s something else the Reserve Bank can do.

Governor Philip Lowe is right to call on governments to spend more, creating “fiscal stimulus”.

But we don’t think that absolves the Reserve Bank of the need to provide more “monetary stimulus”.

Simply put, the Reserve Bank needs to create more inflation. Quite a lot more.

For years now, the bank has chronically undershot its inflation target of 2% to 3% per year. This has to stop.


Consumer price inflation since the Reserve Bank’s 2-3% target


ABS Consumer Price Index, Australia

Inflation plays a vital role in government finances, through its influence on nominal income growth. Higher nominal income growth lowers outstanding debt as a fraction of income.

To appreciate the size of the effect, if average inflation runs at 1.5% per year rather than 2.5% per year (the bank’s central target), after a decade prices will be roughly 10% lower.




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As a consequence, public debt as a fraction of national income will be 10% higher, and that’s before taking into account the revenue implications of lower inflation.

Too much inflation creates its own problems, but so does too little.

Of course, the Reserve Bank’s options are limited right now. Short term interest rates are effectively zero and can’t go much lower without turning negative, an idea the bank has so far resisted.

The bank needs to commit to “too much” inflation

But there are things the bank can do, and they involve making clear its plans for when inflation recovers.

When economic growth revives, be it in 12 or 24 months, the bank will face a choice between raising rates to more normal levels, or continuing to keep them extraordinarily low.

The RBA should do the latter and promise serious inflation, more than it is comfortable with, for some time to come.




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Promising to overshoot its target band will raise inflation expectations and then inflation itself, lowering the real interest rate.

This will buttress the recovery, supporting economic growth. It will also greatly improve the state of government finances.

How much inflation should the RBA generate?

It should aim for average inflation of 2-3% over a long window, at least ten years.

This will place a clear upper bound on how much inflation is appropriate over the long term, while requiring substantial inflation for some time to make up for the sustained undershooting of its target.

It’s being tried in the United States

Such a policy might sound unusual. And there would be protests about credibility and the risks of changing institutional arrangements during a crisis.

But the United States Federal Reserve recently adopted such a policy after an extensive review.

There’s no reason Australia’s Reserve Bank couldn’t do the same.

As it happens, hardly any formal change is required. Its Statement on the Conduct of Monetary Policy says its goal is 2 to 3% inflation “on average, over time.”

So there’s no need to change the wording, merely the interpretation.

It could make clear that a practical change had taken place by referring to the new regime as a “price-level target”, since targeting inflation over a long time is equivalent to targeting a path for the overall level of prices.

It’d hold the bank to account

Regardless of the label, such a clearly enunciated approach would make monetary policy more effective and help the government with its finances.

And that’s not all. An average inflation target would provide a clearer benchmark against which to assess the bank’s performance and thus strengthen the accountability of one of our most important institutions.

Too often in the past the bank has excused its failure to hit its inflation target by appeals to a vague and shifting list of factors outside of its control.




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While some excuses may have merit, the existing regime does not well communicate how such undershooting determines what the bank will do in the future.

By contrast, an average inflation target would clearly communicate that whatever the excuses for undershooting, future policy will be set to overshoot until average inflation is back on target.

It’s appropriate for fiscal policy to take the lead right now. But monetary policy has to be ready to do its job too.The Conversation

Chris Edmond, Professor of Economics, University of Melbourne and Bruce Preston, Professor of Economics, University of Melbourne

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Reserve Bank ‘dallies with indolence’ instead of helping government pursue full employment: Paul Keating


Michelle Grattan, University of Canberra

Former prime minister Paul Keating has launched an extraordinary attack on the Reserve Bank, accusing it of having “one of its dalliances with indolence”, and describing it as “the Reverse Bank”.

Keating, who was treasurer in the Hawke government and once boasted of having the Reserve Bank in his pocket, said the bank’s job was “to help the government meet the task of full employment” and it was failing in this.

He criticised its officials for being “the high priests” of incrementalism, rather than doing what the situation called for.

His outburst, in a statement issued on Wednesday, followed a speech this week by the bank’s deputy governor Guy Debelle who canvassed the pros and cons of options for further monetary policy action if the bank’s board decided it was needed.

These included buying bonds further out along the curve, foreign exchange intervention, lowering rates without going into negative territory, and moving to negative rates.

Keating labelled Debelle’s contribution “meandering thoughts”.

“Knowing full well that monetary policy can now no longer add to nominal demand – something that now, only fiscal policy is capable of doing, the Reserve Bank is way behind the curve in supporting the government in its budgetary funding measures,” Keating said.

“For a moment, it showed some unlikely form in pursuing its 0.25% bond yield target for three year Treasury bonds and a low interest facility for banks.

“But now, after 600,000 superannuation accounts were cleared and closed down, with 500,000 of those belonging to people under 35 – a withdrawal of $35 billion in personal savings, and further demands arising from the employment hiatus in Victoria, [Debelle] yesterday strolled out with debating points about what further RBA action might be contemplated.”

Keating said that in his office when he was treasurer, the bank was nicknamed “the Reverse Bank”, because it was too slow raising rates in the late 1980s and too slow lowering them in the early 1990s – which gave Australia “a recession deeper than it would have otherwise had”.

As treasurer he’d “worn the cost of the bank’s indolence in the task of smashing inflation”. And as a measure of his giving the bank more discretion, as prime minister he’d worn the “great political cost” of the bank’s rate rises in 1994.

“As history has shown, when a real crisis is upon us the RBA is invariably late to the party. And so it is again,” Keating said.

The bank’s act had two objectives – price stability (not a problem at the moment) and full employment, Keating said.

“The Act says the Bank and the government should endeavour to agree on policies which meet that objective – in this case, employment.”

The bank “should be explicitly supporting the government so the country does not experience a massive fall in employment”, hitting particularly younger workers.

But instead of that, Debelle “conducts a guessing competition on what incremental step the Bank might take to help,” Keating said.

“These are the high priests of the incremental. Making absolutely certain that not a bank toe will be put across the line of central bank orthodoxy.

“Certainly not buying bonds directly from the Treasury – wash your mouth out on that one – what would they say about us at the annual BIS meeting in Basel?

“Not even ambitiously buying sufficient bonds in the secondary market, like the European Central Bank or the Bank of Japan.”

He said the bank should “shoulder the load. And in a super-low inflationary world, that load is funding fiscal policy. Mountainous sums of it.

“In an economic emergency of the current dimension that means putting the orthodoxy into perspective and doing what is sensibly required.”

Like other central banks, the Reserve Bank “has become a sort of deity, where lesser mortals might inquire, however respectfully, what the exalted priests might be thinking or have in mind for their prosperity or the country at large,” Keating said.

“The Governor and his deputies do not wear clerical collars and black suits. But that is the only difference in their comport and attitude.”The Conversation

Michelle Grattan, Professorial Fellow, University of Canberra

This article is republished from The Conversation under a Creative Commons license. Read the original article.

No snapback: Reserve Bank no longer confident of quick bounce out of recession



Olga Kashubin/Shutterstock

Peter Martin, Crawford School of Public Policy, Australian National University

The good news in the Reserve Bank’s latest quarterly set of forecasts is that the recession won’t be as steep as it thought last time.

The bad news is it now expects ultra-weak economic growth to drag on and on, pushing out the recovery and meaning Australia won’t return to the path it was on for years if not the end of the decade.

Its so-called baseline scenario, which is for the worst recession in 70 years, relies on a number of things going right:

the heightened restrictions in Victoria are in place for the announced six weeks and then gradually lifted. In other parts of the country, restrictions continue to be gradually lifted or are only tightened modestly for a limited time, although restrictions on international departures and arrivals are assumed to stay
in place until mid 2021

Whereas three months ago in its May update the Reserve Bank expected economic activity to collapse 8% in the year to June 2020 and then bounce back 7% over the following year, it now believes it collapsed a lesser 6% but will claw back only 4% in the year to come.

The direct impact of locked doors and shut shops was smaller than it expected, but the ongoing impacts are “likely to be larger”.

It’ll depend on households

What economic growth there is will be driven by household spending. Business investment, once a key economic driver, won’t be back to anything like where it was until well into 2023.

Business after business has been telling the bank’s liaison officers they have deferred or cancelled planned spending to preserve cash.

In usual times, household spending accounts for 60% of gross domestic product.




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The Reserve Bank believes household spending fell 11% by the middle of the year and will start to edge back up, but it warns that household incomes are expected to slide and unemployment grow as government winds back JobKeeper and JobSeeker:

The JobKeeper program ensures that many more workers remain attached to their job than otherwise. However, it is expected some workers will be retrenched once they are no longer eligible for the subsidy in late 2020 and early 2021. Moreover, the reinstatement of job search requirements for the JobSeeker program outside of Victoria in the September quarter and the lifting of restrictions will result in more people looking for jobs

It will have been heartened by the Prime Minister’s recent decision to make the wind-back of JobKeeper less steep.

The bank says that the way businesses and households adjust to a lower income in the months ahead will be “an important determinant of the outlook over the rest of the forecast period”.


Reserve Bank of Australia

It expects employment to fall further over the rest of the year, as job
losses from restrictions in Victoria and the tightening of JobKeeper more than offset a continued recovery in jobs elsewhere.

One in ten of the businesses it has contacted through its liaison program report wage cuts, most of them targeted towards senior management, but some implemented broadly.




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The proportion reporting wage cuts is “significantly higher” than during the global financial crisis.

By the end of next year the bank expects the published unemployment rate to be somewhere between 11% and 7%.

The forecast range is an indication of how uncertain it is about what will happen.


Reserve Bank of Australia

The bank’s forecasts for recession and recovery have a similarly wide range.

On one hand GDP might not be back to where it was until the middle of the decade, and not back to where it would have been until the start of the following decade.

On the other, it might have made up its losses by the end of next year.


Reserve Bank of Australia

The bank’s central “baseline” forecast points to a worse recession than any since World War II and the Great Depression.


Reserve Bank of Australia

Its upside scenario assumes quick progress in controlling the virus, improving consumer confidence as a result, a quick end to the outbreak in Victoria and no further major outbreaks.

The downside scenario assumes rolling outbreaks and rolling lockdowns along with a widespread resurgence in infections worldwide.

Risks a plenty…

It says if households conclude that low income growth will be more persistent than previously expected, they might “permanently adjust their spending” leaving the economy weaker for longer.

The uncertainty could lower firms’ risk appetite, prodding them to pay down debt and increase cash buffers rather than invest even when conditions recover.




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A sustained period of lower investment, combined with “scarring” as people unemployed or underemployed find themselves unable to improve their position could “damage the economy’s productive potential”.

…little harm in spending

The bank says there’s little more it can do. It has considered negative interest rates, and believes they would be of no real help.

It’ll be up to the government to support the economy with spending. Where needed the bank will buy government bonds with money it creates in order to keep borrowing costs low.

To make the point that government shouldn’t be afraid of borrowing, it includes a graph of government debt since Federation.


Reserve Bank of Australia

Its point is that as a proportion of the economy the government has borrowed and spent much much more in the past.

To the extent that it is needed to make households feel able to spend and businesses able to invest, it is worth it.The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

The Reserve Bank thinks the recovery will look V-shaped. There are reasons to doubt it



Shutterstock/RBA

Peter Martin, Crawford School of Public Policy, Australian National University

The Reserve Bank’s long-awaited two-year forecasts for jobs, wages and growth are frightening, but I fear they are not frightening enough.

The bank looks two years ahead every three months. The last set of forecasts, released at the start of February, mentioned coronavirus mainly as a source of “uncertainty”.

That’s how much things have changed.

Back then economic growth was going to climb over time, consumers were going to start opening their wallets again (household spending had been incredibly weak) and unemployment was going to plunge below 5%.

The forecasts released on Friday come in three sets – “baseline”, a quicker economic recovery, and a slower recovery.

Baseline”, the central set with which we will concern ourselves here, is both shocking, and disconcertingly encouraging.



Reserve Bank Statement on Monetary Policy, May 2020

On employment, it predicts a drop of more than 7% in the first half of this year, most of it in the “June quarter”, the three months of April, May and June that we are in the middle of.

Thirteen million of us were employed in March, making a drop of 7%, a drop of 900,000. Put differently, one in every 13 of us will lose their jobs.

Harder to believe is that by December next year 6% of the workforce will have got them back.

It sounds like what the prime minister referred to earlier in the crisis as a “snapback”, the economy snapping back to where it was.

Except that it’s not.


Reserve Bank Statement on Monetary Policy, May 2020

Six per cent of a small number is a lot less than 7% of a big number.

The bank’s forecasts have far fewer people in work all the way out to mid 2022 (the limit of the published forecasts) and doubless well beyond.

The unemployment rate would shoot up to 10% by June and take a long while to fall.


Reserve Bank Statement on Monetary Policy, May 2020

The baseline economic growth forecast is also drawn as a V.

After economic activity shrinks more than 8% in the June quarter, we are asked to believe it will bound back 7% in the year that follows.

But that will still leave us with much lower living standards than we would have had, missing the usual 2-3% per year increase.


Reserve Bank Statement on Monetary Policy, May 2020

The reason I fear the baseline forecasts aren’t frightening enough is that they are partly built on a return to form for household spending, which accounts for 65% of gross domestic product.

After diving 15% mainly in this quarter we are asked to believe it will climb back 13% in the year that follows.

Maybe. But here’s another theory. While we’ve been restricted in movement or without jobs we’ve become used to spending less (and used to flying less, and used to hanging onto our cars for longer and hanging on to the money we’ve got).




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My suspicion is that these behaviours can be learned, and we’ve been doing them long enough to learn them.

During the global financial crisis we tightened our belts and then kept them tight for years, saving far more than the offical forecasts expected, in part because we had been shocked and felt certain about the future.

A recovery that had been forecast to be V-shaped looked more like a flat-bottomed boat when graphed. It’s a picture I find more believable than a snapback.

We are unlikley to get back where we would have been for a very long time.The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Why the Reserve Bank should fund super funds during the COVID-19 crisis



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Kevin Davis, University of Melbourne

A significant number of wealthy individuals have used the ability of self managed super funds (SMSFs) to borrow for property and other investments to supercharge their funds.

It is not something done by retail and industry funds.

According to freedom of information documents obtained by the Australian Financial Review, in 2018 the largest 100 self-managed super funds had borrowings averaging around A$10 million each.

Given the tax benefits granted to superannuation, this exploitation of the system by Australia’s super-wealthy is scandalous, albeit legal. In 2018 more than 200 members of those biggest 100 self-managed super funds were members of the Financial Review Rich List.

Along with other members of the 2014 Australian Financial System Inquiry chaired by David Murray, I voted enthusiastically for a recommendation to ban borrowing by funds.

Normally, borrowing creates risk

Unfortunately, after intense lobbying from the self-managed super fund sector, the Coalition government rejected that recommendation.

I am sure that each of the panel members put different weights on the arguments as to why “no leverage in super” would be good policy.

I focused on two.

First, leverage can lead to funds taking excessive risk, and it also enables some to “rort” the system by getting more assets into the tax-preferred status of super at the expense of the taxpayer

The second argument is about financial sector stability. Leveraged (indebted) financial institutions can be at risk of insolvency and exposed to runs by creditors. A highly levered financial system with lots of interconnectedness can face problems of fragility. Keeping super “un-levered”, as is generally the case for institutional super funds, would be good for stability.

These are not normal times

But even funds that can’t borrow, such as retail and industry funds, face problems if there is a “run” of members wishing to withdraw money.

That could arise because, believing that there are legislated limits on when members can access funds, they have invested significant amounts in longer term, illiquid assets such as toll roads, airports and office buildings in order to produce superior long term returns.

Changing the rules on when members can withdraw funds, such as with the current change to allow withdrawals of up to $20,000, pressures funds to sell off assets they had planned on holding to generate enough cash to meet withdrawals.

Between $30 billion and $50 billion may have been pulled out already.

It isn’t a good time to be selling assets. Depressed sale prices mean the value of all members’ accounts will be further depressed.

Super funds could borrow to obtain the cash needed to meet withdrawals. But that would expose their members to considerable risk if asset prices fell further. They would have to have to pay back the loan from assets that were worth less.

For now, I’ve changed my mind

But if the liquidity problem is purely temporary, brought on by a temporary change in legislation, borrowing might not be such a bad option compared to a forced sale of assets.

While I have not changed my view on prohibiting borrowing in general, I think current circumstances warrant a limited exception.

That exception is that where there is a temporary liquidity problem, brought on by a government change in rules, the institutional super funds should be able to borrow from the Reserve Bank.

Banks can borrow from the Reserve Bank in emergencies. Why not super funds?




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In this regard, I am at variance with commentators like David Murray and indeed the Reserve Bank itself. Moreover, I think there are reasonable arguments for making access to the Reserve Bank ongoing.

Bank access to the Reserve Bank, often referred to as the Reserve Bank being a “lender of last resort” is not about bailing out insolvent institutions. It is about providing temporary liquidity, at a price, to solvent, but illiquid institutions.

And the current issue is one of illiquidity, not insolvency. In principle at least, unlevered accumulation funds can’t go insolvent. If the value of assets falls, liabilities (amounts due to members) fall correspondingly.

The government should fix a problem it created

When an unexpected policy change creates a liquidity problem for super funds, it behoves policy makers to find a solution that avoids the need for funds to generate cash by selling assets at depressed prices.

Allowing super funds to borrow from the Reserve Bank using repurchase agreements would be such a solution. And since the need for liquidity is a consequence of the policy change, those borrowings should not attract a penalty interest rate.

It is important to note that these borrowings are different to the type we argued against in the financial system inquiry.




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There, we were concerned about funds increasing the size of their portfolios by borrowing and taking on additional risks.

Here, the borrowings would enable funds to avoid shrinking their portfolios and enable them to reduce the risks and costs they (more precisely their members) face.

And consider making the fix permanent

My suggestion is that while borrowings by super funds should generally be prohibited, accessing temporary liquidity support from the Reserve Bank should not be part of that prohibition.

If access to such a facility is made ongoing, there would be a case for offering it at penalty interest rates and subjecting funds to liquidity regulation. But those are questions best left for reasoned discussion in more settled times.

Oh, and there has to be a severe crackdown on the ability of wealthy individuals to rort the tax benefits of super by borrowing through their self-managed super funds.

For the government to allow such borrowings but not support institutional funds by allowing borrowing from the Reserve Bank in times of crisis seems, at best, anomalous.The Conversation

Kevin Davis, Professor of Finance, University of Melbourne

This article is republished from The Conversation under a Creative Commons license. Read the original article.

We asked 13 economists how to fix things. All back the RBA governor over the treasurer


Peter Martin, Crawford School of Public Policy, Australian National University

Thirteen leading economists have declared their hands in the stand off between the government and the Governor of the Reserve Bank over the best way to boost the economy.

All 13 back Reserve Bank Governor Philip Lowe.

They say that, by itself, the Reserve Bank cannot be expected to do everything extra that will be needed to boost the economy.

All think that extra stimulus will be needed, and all think it’ll have to come from Treasurer Josh Frydenberg, as well as the bank.

All but two say the treasurer should be prepared to sacrifice his goal of an immediate budget surplus in order to provide it.

The 13 are members of the 20-person economic forecasting panel assembled by The Conversation at the start of this year.

All but one have been surprised by the extent of the economic slowdown.




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The 13 represent ten universities in five states.

Among them are macroeconomists, economic modellers, former Treasury, IMF, OECD and Reserve Bank officials and a former government minister.

The Bank needs help

At issue is the government’s contention, spelled out by Frydenberg’s treasury secretary Steven Kennedy in evidence to the Senate last month, that there is usually little role for government spending and tax (“fiscal”) measures in stimulating the economy in the event of a downturn.

Absent a crisis, economic weakness was “best responded to by monetary policy”.

Monetary policy – the adjustment of interest rates by the Reserve Bank – is nearing the end of its effectiveness in its present form. The bank has already cut its cash rate to close to zero (0.75%) and will consider another cut on Tuesday.

It is preparing to consider so-called “unconventional” measures, including buying bonds in order to force longer-term interest rates down toward zero.




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Governor Lowe has made the case for “fiscal support, including through spending on infrastructure” saying there are limits to what monetary policy can achieve.

The 13 economists unanimously back the Governor.

Seven of the 13 say what is needed most is fiscal stimulus (including extra government spending on infrastructure), three say both fiscal and monetary measures are needed, and three want government “structural reform”, including measures to help the economy deal with climate change and remove red tape.

None say the Reserve Bank should be left to fight the downturn by itself without further help from the government.

There is plenty of room for fiscal stimulus, particularly infrastructure spending – Mark Crosby, Monash University

I agree with the emerging consensus that monetary policy is no longer effective when interest rates are so low – Ross Guest, Griffith University

It is time for coordinated monetary and fiscal policies to boost domestic demand – Guay Lim, Melbourne Institute

The surplus can wait

Eleven of the 13 believe the government should abandon its determination to deliver a budget surplus in 2019-20.

Renee Fry-McKibbin. Ease surplus at all costs.
ANU

Economic modeller Renee Fry-McKibbin says the government should “ease its position of a surplus at all costs”.

Former Commonwealth Treasury and ANZ economist Warren Hogan says achieving a surplus in the current environment would have “zero value”.

Former OECD director Adrian Blundell-Wignall says that rather than aiming for an overall budget surplus, the government should aim instead for an “net operating balance”, a proposal that was put forward by Scott Morrison as treasurer in 2017.

The approach would move worthwhile infrastructure spending and borrowing onto a separate balance sheet that would not need to balance.

Political debate would focus instead on whether the annual operating budget was balanced or in deficit.

Former treasury and IMF economist Tony Makin is one of only two economists surveyed who backs the government’s continued pursuit of a surplus, saying annual interest payments on government debt have reached A$14 billion, “four times the foreign aid budget and almost twice as much as federal spending on higher education”.

Tony Makin. Surplus needed for budget repair.
Griffith University

Further deterioration of the balance via “facile fiscal stimulus” would risk Australia’s creditworthiness.

However Makin doesn’t think the government should leave everything to the Reserve Bank.

He has put forward a program of extra spending on infrastructure projects that meet rigorous criteria, along with company tax cuts or investment allowances paid for by government spending cuts.

Former trade minister Craig Emerson also wants an investment allowance, suggesting businesses should be able to immediately deduct 20% of eligible spending.

It’s an idea put forward by Labor during the 2019 election campaign. Treasurer Josh Frydenberg has indicated something like it is being considered for the 2020 budget.

Emerson says it should be possible to deliver both the investment allowance and a budget surplus.

Quantitative easing would be a worry

Five of the 13 economists are concerned about the Reserve Bank adopting so-called “unconvential” measures such as buying government and private sector bonds in order to push long-term interest rates down toward zero, a practice known as quantitative easing.

Jeffrey Sheen and Renee Fry-McKibbin say it should be kept in reserve for emergencies.

Adrian Blundell-Wignall and Mark Crosby say it hasn’t worked in the countries that have tried it.

A quantitative easing avalanche policy by the European central bank larger than the entire UK economy has left inflation below target and growth fading. Quantitative easing destroys the interbank market, under-prices risk, and encourages leverage and asset speculation – Adrian Blundell-Wignall

Steve Keen says in both Europe and the United States quantitative easing enriched banks and drove up asset prices but did little to boost consumer spending, “because the rich don’t consume much of the wealth”.

The treasurer should step up

Taken together, the responses of the 13 economists suggest it is ultimately the government’s responsibility to ensure the economy doesn’t weaken any further, and that it would be especially unwise to palm it off on to the Reserve Bank at a time when the bank’s cash rate is close to zero and the effectiveness of the unconventional measures it might adopt is in doubt.

Measures the government could adopt include increasing the rate of the Newstart unemployment benefit, boosting funding for schools and skills training, borrowing for well-chosen infrastructure projects with a social rate of return greater than the cost of borrowing, further tax cuts that double as tax reform (including further tax breaks for business investment) and spending more on programs aimed at avoiding the worst of climate change and adapting to it.

The economists are backing the governor in his plea for help. They think he needs it.


The 13 economists surveyed




Read more:
Buckle up. 2019-20 survey finds the economy weak and heading down, and that’s ahead of surprises


The Conversation


Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

0.75% is a record low, but don’t think for a second the Reserve Bank has finished cutting the cash rate


Peter Martin, Crawford School of Public Policy, Australian National University

Anyone who thought that with the Reserve Bank’s cash rate now close to zero, its run of interest rate cuts was over, needs only to read the last sentence of Governor Philip Lowe’s announcement after Tuesday’s cut:

The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

For the longest time, the run of cuts was over.

Lowe’s immediate predecessor, Glenn Stevens, cut the cash rate to a record low of 1.5% in August 2016 as something of a “parting gift”, allowing Lowe to take over and keep it steady, unchanged for a record 34 months.

For most of those three years he made it clear the rate was unlikely to fall further. Six times he said the next move in rates was likely to be up, “rather than down”, pointing to rate increases overseas and progress on jobs and returning Australia’s unusually low inflation rate to his target band.

By February this year he was backtracking. Although it wasn’t apparent in the published figures, the unemployment rate was about to begin climbing. Wage growth had been far weaker than forecast, inflation showed no sign of returning to the centre of his target band, and forecasts for global growth were falling.


Reserve Bank cash rate


Source: RBA

More importantly, consumer spending, which accounts for six in every ten dollars spent in Australia, was extraordinarily weak, growing at less than half the usual rate, as households “responded to this extended period of weaker income growth by progressively downgrading their spending plans”.

The probabilities of next move being up and down had become “more evenly balanced”.




Read more:
RBA update: Governor Lowe points to even lower rates


Two weeks after the May election he cut the cash rate, then cut it again, taking it to a new record low of 1%, anticipated by only two of the 19 economists surveyed by The Conversation just six months earlier.

The extra cut announced on Tuesday is because the last two didn’t do enough.

House prices have begun to move up (as would be expected with lower rates) but borrowing is growing only slowly, and home building is weak. The Australian dollar is low (in part because of the lower rates), which should help make Australian businesses competitive, but they are not keen to borrow.

Since the last Reserve Bank board meeting we have learned that economic growth is shockingly low, just 1.4% over the past year, the weakest since the global financial crisis. Household spending is barely keeping pace with population growth.

Lowe would like to believe the economy has reached “a gentle turning point”. He told a community dinner in Melbourne on Tuesday night the board thinks it might have.

There are a number of factors that are supporting this outlook. These include the low level of interest rates, the recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets, and a brighter outlook for the resources sector.

But they will need help. The bank believes the economy is capable of producing an unemployment rate of 4.5%. Instead it has been climbing, to 5.3%.

How the cuts will help

The cash rate is determined by the rate the Reserve Bank pays banks who deposit with it overnight. It drives almost every other rate, including the rates banks pay retail depositors, which help determine their cost of lending.

They don’t have to cut their mortgage and business rates in line with cuts in the Reserve Bank cash rate, but they usually do.

The big banks played a game of chicken yesterday, each waiting for the other to move. The Commonwealth Bank moved first, offering just 0.13 of the 0.25 points, followed by the National Australia Bank, which offered 0.15 points.

The real action is in the discounted rates that target borrowers for whom they matter. Before Tuesday they averaged 3.46%. Some were much lower. HSBC Australia wanted just 3.17%. If it passes on Tuesday’s cut in full it will charge only 2.92%, offering the first Australian mortgage rate in history beginning with the number “2”.

There’s every reason to believe the cuts will help. Even if Australians don’t borrow more to buy houses, they will be able to use the historically cheap credit embodied in their house loans to buy other things, such as solar panels whose payoff period will have shortened dramatically.

Since June many mortgage-holders will have saved A$150 on monthly payments.

Sure, confidence and decent wage growth would help, but given how indebted many Australians are, low mortgage rates will do quite a bit on their own.

Why they’ll continue

Governor Lowe made it clear on Tuesday that they will have to stay low for “an extended period”. A signed agreement with the treasurer requires him to keep them low until unemployment falls and inflation and economic growth return to return to normal levels.

He would like the government to help by boosting spending. He often mentions spending on infrastructure. But his employment contract requires him to use the cards he has been dealt. If the economy is weak, he is required to boost it using the instruments he has.




Read more:
Below zero is ‘reverse’. How the Reserve Bank would make quantitative easing work


That’s why he says he is prepared “to ease monetary policy further”.

If needed, he’ll do it as soon as next month, cutting the cash rate to 0.5%. If more is needed beyond that, he will get ready to use so-called unconventional measures of the kind being used overseas, buying government and corporate bonds in order to force even more money into Australian’s hands.

There’s no reason to believe that the tools he has won’t work, and every reason to believe he’ll keep using them.The Conversation

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

RBA update: Governor Lowe points to even lower rates


Peter Martin., Crawford School of Public Policy, Australian National University

Reserve Bank Governor Philip Lowe has said two things about unemployment in the past few weeks. Together, they lead to an inescapable conclusion.

The first was in a speech in May, expanded on in a speech in June. At both times the published unemployment rate was 5.2%.

Lowe said in May that while the Reserve Bank had long thought an unemployment rate of 5% was the best that could be achieved without generating worrying inflation, that view has now changed:

From today’s perspective, I think we can do better than this. My judgement of the accumulating evidence is that the Australian economy can support an unemployment rate of below 5% without raising inflation concerns.

It was good news. And then it got better.

In June he put a number on how low the unemployment rate could go before inflation became a concern:

While it is not possible to pin the number down exactly, the evidence is consistent with an estimate below 5%, perhaps around 4.5%. Given that the current unemployment rate is 5.2%, this suggests that there is still spare capacity in our labour market.

The Reserve Bank should be able to cut interest rates until unemployment fell below 5% and approached 4.5% without worrying about inflation, Lowe argued.

And in May, in a report back from a board meeting, he made it clear that’s what he would do:

At that meeting, we discussed a scenario in which there was no further improvement in the labour market and the unemployment rate remained around the 5% mark. In this scenario, we judged that inflation was likely to remain low relative to the target and that a decrease in the cash rate would likely be appropriate.

It would likely be appropriate to cut interest rates and keep cutting until the unemployment rate was driven below 5%, continuing to cut until it approached 4.5%.

Today, appearing before the House of Representatives economics committee in Canberra with the unemployment rate still stuck at 5.2% despite two consecutive rate cuts, he delivered what on the face of it was bad news.

He said the bank’s central forecast was that the unemployment rate would stay above 5% again until 2021. That’s right, 2021.

But taking the two statements together, it is reasonable to conclude that the Reserve Bank will keep cutting rates until unemployment does fall below 5%. In other words, it will keep cutting rates until 2021.

Lowe ain’t done cutting…

Indeed, the Reserve Bank’s quarterly forecasts update, released as Lowe spoke, countenances that happening. As foreshadowed by the governor, it forecasts that the unemployment rate won’t fall back to 5% until June 2021.

And it contains several other unwelcome forecasts: economic growth of just 2.5% this year, down from a previously forecast 2.75%, and very weak inflation this year of just 1.75%, down from a previously forecast 2%.



RBA Statement on Monetary Policy, August 9, 2019

But here’s the thing. All of those forecasts were compiled, as is the Reserve Bank’s custom, by taking into account not only the two interest rate cuts that have already happened (and have taken the bank’s cash rate down to an all-time low of 1%), but also two more yet to be delivered.

It is explained in the footnote:

Technical assumptions set on 7 August include the cash rate moving in line with market pricing.

The “market pricing” is the consensus of the bets placed on the futures market for what the Reserve Bank is going to do to its cash rate.

The consensus is for another cut of 0.25% in October and then another cut of 0.25% in February, taking the cash rate down to yet another all-time low of just 0.5%.



ASX target rate tracker

The Reserve Bank is normally at pains to point out that this is a mere technical assumption, not a guarantee of how it will move rates. But the awful truth is that its forecasts imply that unless it cut rates two more times in coming months, unemployment won’t fall to 5% by 2021, and inflation will be even weaker than the incredibly weak 1.75% it is forecasting.

…and he might not stop at zero

Two more cuts in its cash rate will take it to 0.5%, close to zero.

Lowe revealed that the Reserve Bank is investigating so-called “unconventional” monetary policy or quantitative easing that would have the same effect as taking the cash rate below zero.

“It is prudent for us to have done the work in advance to see what we would do – it’s really contingency planning,” he said.

Rates might go to zero, or below, worldwide because right now there is a worldwide glut of savings, and not enough investment.

The reality we face is that, if a lot of people want to save and not many people want to use those savings to build new capital, savers are going to get low returns. We can move our interest rates around this new structurally lower level,but we can’t escape the fact that global interest rates are low.

The Reserve Bank’s best case is that its Australian forecasts are wrong – that unemployment actually falls and that inflation, wage growth and economic growth climb.

There’s a respectable view within the bank that this might happen. Its forecasts take into account a range of positive influences, including lower interest rates, the recent tax cuts, the depreciation of the Australian dollar, a brighter outlook for investment in the resources sector, some stabilisation in the housing market, and ongoing high levels of investment in infrastructure.




Read more:
Below zero is ‘reverse’. How the Reserve Bank would make quantitative easing work


But they are the result of a mechanical model that takes them into account individually. The governor’s hope is that, taken together, they will achieve more than is forecast.

He would like governments themselves to push things along, starting with the wages they pay their own employees, and he is becoming ever more bold about saying so:

Most public sectors have wage caps of 2.5%, some have 1.5%, I think in Western Australia it’s probably even lower. I can understand why governments are doing that. On the other hand, the wage caps in the public sector are cementing low wage norms across the country. Over time, I hope the whole system, including the public sector, could see wages rising at three point something.

He is as good as powerless to stop what he regards as a worldwide investment strike caused by the trade and technology disputes between the United States and China.

These disputes pose a significant risk to the global economy. Not only are they disrupting trade flows, but they are also generating considerable uncertainty for many businesses around the world. Worryingly, this uncertainty is leading to investment plans being postponed or reconsidered.

Lowe doesn’t believe further interest rate cuts would to do much to encourage businesses to invest, or to encourage home buyers to borrow.

But he is certain they will help in other ways.

They will lower the exchange rate, making Australian goods and services more competitive, and that they will free up the cash of Australians who already have home loans, what he calls the “cash flow” channel:

There is no evidence that has become less effective. It is certainly true that in the current environment, at least in my view, monetary policy is less effective than it used to be. In today’s environment people don’t run off to the bank to borrow more when interest rates fall; they are more likely to pay back their mortgage more quickly. So that dynamic is different than it used to be.

When he last appeared before the parliamentary committee in February he said the probabilities of rates going up and rates going down were evenly balanced. He didn’t say that today.




Read more:
Buckle up. 2019-20 survey finds the economy weak and heading down, and that’s ahead of surprises


The Conversation


Peter Martin., Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Back-to-back Reserve Bank cuts take interest rates to new low of 1%


Michelle Grattan, University of Canberra and Peter Martin, Crawford School of Public Policy, Australian National University

The Reserve Bank has cut the official interest rate by another 0.25 percentage points to a new low of 1%, reflecting continuing concern over the slow economy.

Reserve Bank Governor Philip Lowe said the latest cut, which came a month after the RBA made a similar cut of 0.25 percentage points, would help “make further inroads” into the economy’s spare capacity, assist in reducing unemployment, and achieve more progress towards the inflation target. The last back-to-back reduction was in 2012.

Treasurer Josh Frydenberg said the government “expects all banks to pass on the benefits of sustained reductions in funding costs.” ANZ Bank immediately announced it would pass on the full cut. On June 4 it passed on just 0.18 points of the 0.25 point cut.

The Commonwealth and National Australia banks will pass on 0.19 of the 0.25 points. Westpac will pass on 0.20 points for owner-occupiers and 0.30 points for investors with interest only loans.


Reserve Bank cash rate since 1990


Reserve Bank of Australia

The Reserve Bank made it clear it could cut further if necessary.

The wording of Lowe’s statement makes clear that he will continue to cut rates until the unemployment rate falls, probably to around 4.5%, which the bank has identified as a target consistent with its inflation target.

Sub-5% unemployment the new RBA target

Over the past six months, the unemployment rate has climbed from 5% to 5.2%, instead of falling as the bank believes it should.

Lowe’s statement says the Australian economy “can sustain lower rates of unemployment and underemployment”. It says its inflation target of 2-3% is not at risk. It expects underlying inflation to climb from its present 1.4% to around 2% in 2020 and then a little higher after that.

After the announcement, JP Morgan predicted another two cuts, taking the cash rate from 1% to 0.5% by mid next year. It said the risks to this view were that the bank “gets there earlier, not later”.

The cut in the cash rate will bring many mortgage rates down to less than 4% for the first time in records that date back to 1959.




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The latest Reserve Bank decision comes as the Coalition government gathers the Senate numbers to pass its income tax package this week. The first tranche will provide an early stimulus to the economy.

Frydenberg said the government’s economic plan, “including significant tax cuts of which the legislation will be introduced into the parliament today, will boost household consumption and overall economic activity”.

While the Reserve Bank described the outlook for both the global and domestic economies as “reasonable”, it pointed to uncertainties in each.

The central scenario for the Australian economy remains reasonable, with growth around trend expected. The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in household disposable income is expected to support spending.

Lowe pointed out that while there had been a pick up in private sector wages growth, “overall wages growth remains low”.

Labor puts the case for bringing tax cuts forward

Shadow Treasurer Jim Chalmers said “two rate cuts in two months are a damning indictment of the Liberals’ economic mismanagement”.

Rates are now a third of their level during the global financial crisis of the late 2000s, he said.

Chalmers said the decision to cut rates boosted the case for Labor’s proposed amendments to the tax package. These amendments would embrace the first stage of the tax plan, bring forward some of stage two and drop the third stage.

But the government is insisting the package must go through without change, and is negotiating with the crossbench to bypass Labor if necessary.




Read more:
Stages 1 and 2 of the tax cuts should pass. But Stage 3 would return us to the 1950s


In his speech opening the parliament on Tuesday, Governor-General David Hurley said the government believed “a strong economy is the foundation of the compact between Australians and their government”.

“A strong economy makes us more resilient when economic shocks and global headwinds confront our country,” he said, in an address that is written by the government.

My government understands that you can’t take economic growth for granted and it requires continual work – in improving confidence, competitiveness and productivity.

The speech outlined the government’s program but did not contain anything new.

In the first meeting of the Coalition parties in the new parliament, Prime Minister Scott Morrison said he wanted the government to be known for its humility and urged his troops to be humble.

He declared this as “the year of the surplus” – a reference to the budget’s promise of a return to surplus this financial year.




Read more:
Buckle up. 2019-20 survey finds the economy weak and heading down, and that’s ahead of surprises


The Conversation


Michelle Grattan, Professorial Fellow, University of Canberra and Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.