Co-author: Shay Waraker
Quantitative easing has been used before by some central banks around the world to try to spark recovery in struggling economies. What is it and how will it be used in Australia?
What is quantitative easing or QE?
Put simply, quantitative easing (QE) is a type of unconventional monetary policy whereby central banks increase the supply of money to the economy to try to boost inflation and avoid or get out of a recession. They typically don’t do it by literally printing extra money though, as is a common assumption.
Most central banks instead use their cash reserves to buy government bonds or other financial assets, which starts the process of stimulating a spending cycle. It’s like a central bank taking money from its own wallet and buying something from the government or a regular bank. The seller then has more cash to give to people – perhaps in the form of tax cuts, in the government’s case, or loans if it’s a bank. The idea is that people who get one of those tax cuts or loans will spend the money – perhaps buying a house or car or starting a business – which helps the economy to grow.
There’s another way that QE could help get the economy moving again – it typically contributes to lower interest rates, too. When banks have more funds available to finance more loans, people can potentially find it easier to shop around to find the best deal. Competition is increased, and interest rates start to go down. Lower interest rates are meant to encourage more spending, which results in increased demand for goods and services, creates more jobs and ultimately stimulates the economy… in theory.
The effectiveness of QE as a monetary policy tool is commonly debated. The Bank of Japan has used it – along with other unconventional forms of monetary policy – over the past few decades in an effort to revive Japan’s deflated economy, but critics say it has ultimately failed to create real growth – the country now has negative interest rates. Starting in late 2008, the United States’ Federal Reserve also used QE to try to bail the country out of the Global Financial Crisis, while the Bank of England and European Central Bank have also used QE in various forms over the past decade or so.
How is Australia using quantitative easing?
On 3 November 2020, the RBA Board announced it would implement QE to help stimulate the economy. It will do so by purchasing $100 billion worth of government bonds over the next six months (made up of approximately 80% federal and 20% state and territory government bonds), predominantly with maturities around 5-10 years. This is the first time Australia has used QE measures.
By purchasing government bonds, the RBA will receive regular interest payments from the government for the life of the bond, with the investment amount repaid at the end.
”It is important to point out that the bond purchases by the RBA will have to be repaid by the Government at maturity,” RBA Governor Philip Lowe said.
“They will have to be repaid in exactly the same way as would occur if the bonds were held by others.
“The fact that the RBA is holding some bonds makes no difference to the financial obligations of the government, other than through a lower cost of finance.”
The RBA will be purchasing the bonds from the ‘secondary market’ in auctions three times a week. Basically, institutional investors, such as banks (both foreign and local), purchase bonds directly from the government, and then the RBA will purchase them from these investors in what is called the secondary market.
By purchasing the bonds, the RBA effectively increases demand for them, which leads to a decrease in interest rates for those bonds. This then enables the governments that initially sold the bonds to borrow money at lower rates. It is also anticipated to put downward pressure on the Australian dollar, which is usually a positive thing for Australian exporters. The dollar is pushed down because lower interest rates makes Australia less attractive to foreign investors, and that leads to lower demand for the currency. When demand for a currency is low, the value of the currency is usually lowered, which in this case would result in Australian products becoming cheaper and thus more attractive to overseas buyers.
Where does the RBA get the money from to buy the bonds? Technically, they are creating the money and spending it in an effort to stimulate and support the economy. When Ben Bernanke, then-chairman of the US Federal Reserve, was asked during the GFC whether the Fed was printing money, he responded “well, effectively. We’re electronically printing it. Their accounts used to have this much and now they have an extra $100 million and we’ve got the bond.”
Is quantitative easing the same as ‘helicopter money’?
While they are related forms of monetary policy aimed at growing the economy, helicopter money and quantitative easing are quite different. Helicopter money is a strategy that involves a central bank attempting to increase consumer spending by supplying large amounts of newly “printed money” to the public, as if the money were being dropped from a helicopter – hence the term “helicopter money”.
By comparison, QE does not make cash directly available to consumers. It gives banks the boost if the central bank buys assets from the secondary market, or the government if it buys bonds directly from the government. Another major difference between QE and helicopter money is that with the latter, there is no asset being purchased by the central bank that it can later sell to re-tighten things again, meaning helicopter money is generally less reversible than QE.
Helicopter money, if used in Australia, would most potentially involve the RBA financing government expenditure – such as tax cuts or “gifts” to households – and money would be added to bank accounts (physical banknotes most likely wouldn’t actually be printed). The money the RBA would give to the government would be interest-free and the government wouldn’t have to pay back the debt to the central bank.
While helicopter money might increase consumer consumption, it’s generally seen as a “last resort” strategy because it could lead to outcomes such as currency devaluation, hyperinflation or irresponsible government spending. On the flip side, a possible advantage of helicopter money is that since it is effectively ‘free money’ for consumers and doesn’t have any interest attached, it’s arguably more likely to have a quick impact on consumer spending, as suggested by some economists.
Thanks for visiting Canstar, Australia’s biggest financial comparison site*
Header image: EyeofPaul (Shutterstock)