Failure to proceed with QE will doom a younger generation to dismal life chances to contain inflation that is as dead as Monty Python's parrot.
Yet again the Reserve Bank has been dragged by international reality into shifting its position on monetary policy, making it the tardiest central bank in the developed world in responding to these challenging economic times. It is a conservatism that Australia’s central bank considers prudent but running a tighter monetary policy than our competitors for the last half dozen years has already come at the cost of several hundred thousand Australian jobs.
Governor Lowe’s speech last week signalled the Reserve Bank’s acceptance it has consistently missed its mandated targets for both inflation and unemployment. The stance of monetary policy has been to avoid any risk that the inflation rate might actually slip into the 2-3 per cent band where it is meant to be.
Relying on textbooks from the 1980s, the Reserve Bank has been determined to kill inflation first, before worrying too much about unemployment, despite it being pretty much dead since the introduction of the GST two decades ago.
In Pythonesque terms, at Martin Place they’ve been telling markets the inflation dragon is actually a Norwegian Blue parrot – not dead, just resting, pining for the fjords, ready to recuperate at any moment.
At last, however, Governor Philip Lowe has acknowledged that it is not enough for inflation to be forecast to be in the target range, it must actually be there
https://www.afr.com/markets/currencies/the-reserve-bank-s-new-qe-explained-20201016-p565qm. There was no prospect of it being in the target range in the pre-pandemic world of secular stagnation. And the Norwegian Blue will not take flight in the post-pandemic world of the highest unemployment and underemployment rates since the Great Depression.
Obsessed with fighting inflation, the Reserve Bank has refused to engage in quantitative easing, wilfully running a tighter monetary policy than the rest of the developed world.
Yes, the Reserve Bank has cut the cash rate to just 0.25 per cent. After describing this as the effective lower bound, the Reserve Bank is now contemplating cutting it further to 0.10 per cent on Melbourne Cup Day.
But in a liquidity trap – where households and businesses refuse to borrow more at any interest rate because they feel too insecure to do so – further reductions in the cash rate are unlikely to stimulate the economy.
Belatedly, recognising that Australia's long-term bond rates have become the developed world’s highest – producing an uncompetitively high exchange rate – the Reserve Bank appears set to join the quantitative easing club.
As pointed out in a chart prepared by Saul Eslake’s Corinna Economic Advisory, central banks in the developed world have absorbed 50-75 per cent of national government debt issued since the onset of the pandemic while Australia’s Reserve Bank has absorbed about 25 per cent.
Those of us who have been calling on the Reserve Bank to monetise some of the ballooning government debt https://www.afr.com/policy/economy/how-to-defuse-the-virus-debt-bomb-20200406-p54he5 including Paul Keating https://www.afr.com/policy/economy/no-help-from-high-priests-of-the-reverse-bank-20200923-p55ygm and former NSW Treasury Secretary, Percy Allan https://www.afr.com/policy/economy/how-to-avoid-a-september-cliff-edge-20200629-p5573z are being branded disciples of modern monetary theory, which postulates there is no virtually limit to the amount of debt a government with its own currency can issue.
This has never been our argument. But just as absurd as modern monetary theory is the proposition that the level of money supply before the pandemic struck was optimal for Australia and remains optimal during the deepest recession since the Great Depression.
Of course, the Reserve Bank should be concerned that, in ordinary times, a government might find monetising debt a nifty way of financing spending to boost its re-election chances. But these are not ordinary times. There is so much excess capacity in the economy, including slack in the labour market, that government support for the economy is both essential and non-inflationary.
And if the independent Reserve Bank ever felt the amounts of debt being raised were excessive and their purposes unworthy, it retains at its disposal tools such as interest rates and prudential requirements on commercial banks to dampen the economy and keep the Norwegian Blue in its cage.
To avoid any perception that the Reserve Bank might be planning to monetise part of the debt, such that not all the debt will actually be repaid, it will maintain the façade of buying bonds in the secondary market, not directly from the Treasury. That is, if the Treasury issues long-term government bonds, the Reserve Bank will not be a buyer because that looks shonky. But if a commercial bank buys those bonds and Treasury buys them from the commercial bank the same week well, that’s ridgy-didge.
If that makes the Reserve Bank more comfortable then it can continue with the pretence.
The substantive question is what the Reserve Bank will do with the long-term bonds when their term matures. If they redeem them from the Treasury, such that the Treasury pays the Reserve Bank the coupon value of the bonds, then the debt is indeed repaid. But if the Reserve Bank just sits on them the debt is monetised.
As long as the federal government continues to insist that every dollar of the debt must be repaid, it runs the risk of withdrawing fiscal support too early, prolonging the recession and lengthening the dole queues. It has already signalled that it considers Labor’s childcare reforms to restore work incentives for mothers are unaffordable. Will it cut JobSeeker too hard and terminate JobKeeper prematurely?
Governor Lowe’s speech last week might be a welcome indication that the Reserve Bank will not be a willing accomplice in the destruction of the life chances of a generation of young people, especially young women. That would constitute genuine progress.
Craig Emerson is a distinguished fellow at the ANU, director of the Australian APEC Study Centre at RMIT and adjunct professor at Victoria University’s college of Business.