Podcast: Quantitative easing as a long-term strategy

About the author:

Michael Knox
Author name:
By Michael Knox
Job title:
Chief Economist and Director of Strategy
Date posted:
01 October 2020, 12:05 PM

"On 22nd September 2020, Deputy Governor of the Reserve Bank of Australia, Guy Debelle, delivered a paper to a virtual conference of the Australian Industry Group titled "The Australian Economy and Monetary Policy".

"He said he had three topics. The first was the current state of the Australian economy. The second was to explain how monetary policy actions that the Reserve Bank has taken are working to support the Australian Economy. Finally, he outlined the possibilities for further monetary policy action."

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How long will Quantitative Easing continue?

Quantitative easing is new in Australia, so we tend to think of It as a short-term action that won’t be sustained for very long. Experiences in other countries though have been very different.

Let’s look at the US. The Federal Reserve began it’s first experiments in quantitative easing in November 2008. Back then, US unemployment stood at 6.8%. Quantitative easing didn’t stop unemployment from rising. In fact, unemployment then peaked about a year later in October 2009 at 10%.

From that time on, however, continued quantitative easing allowed the economy to recover. Unemployment gradually fell to September 2014 at which time the Fed brought an end to quantitative easing. The difference between the beginning of quantitative easing during this period and the end was fully 5 years and 10 months. In the US, quantitative easing was not a short-term strategy, but it was in practice a long-term strategy.

How did the Fed decide that the time to end quantitative easing had arrived? Let's look at some of the indicators. Firstly, by September 2014, unemployment had fallen to a number with a 5 in front of it.

The number for US unemployment in September 2014 was 5.9%. Perhaps more importantly though inflation which had fallen as low as 0.9% in October 2009 had risen by September 2014 to 1.7% on the core Personal Consumption Deflator (PCD). This core PCD level of 1.7% was very close to the Feds target for inflation of 2%.

The Deputy Governor noted that the three-year yield target for Australian three-year bonds is aligned with the board’s guidance about the future direction of the cash rate. It will keep buying bonds as long as it wants the cash rate to stay at the current level.

He goes on 'The board has stated consistently that it will not increase the cash rate target until progress is made towards full employment and it is confident that inflation can be sustained within the 2%-3% target band.'

The bank expects that unemployment will rise to 10% at the end of 2020 and gradually decline to be 7% by the end of 2022. He notes that there would still need to be a further decline in the unemployment rate before the Australian labour market would be nearing full employment.

He notes that prior to the pandemic the unemployment rate was about 5% but even this low level was not low enough to generate sufficient wage growth consistent with achieving the inflation target. Under the current scenario it would be more than three years before sufficient progress was being made towards full employment to be confident that inflation would be sustainably within the target band.

He notes that it is highly unlikely that the cash rate will be raised within that three-year time period.

How high can the RBA’s balance sheet go?

International comparisons tell us that the increase of the size in the Reserve Bank of Australia’s balance sheet could have a long way to run. The website of the US Federal Reserve shows us that as of August 12th the total size of the balance sheet of the Federal Reserve was $US6.967 trillion.

This was 34% of US GDP. The Bank of America forecasts that the size of the Fed balance sheet will rise to 48% of US GDP by year end.

In comparison, the balance sheet of the RBA rose to 170 billion Australian dollars in February or 8.52% of GDP to 300 billion Australian dollars now or 15% of GDP. This means that the current size of the RBA balance sheet is less than half of the current size of the US Federal Reserve balance sheet relative to GDP.

In Australia, quantitative easing is something new. It is natural to think that this won’t be maintained for long. The experience in other countries however reveals something different. When the Federal Reserve began quantitative easing in November 2008, it did not end that quantitative easing until almost 6 years later in September 2014.

Guy Debelle appears to suggest that quantitative easing will continue as long as the cash rate remains at its current low level. He doesn’t believe that the current low level of the cash rate will be moved until unemployment is at 5% or lower.

In his address he says that he doesn’t expect that unemployment will be at 7% until the end of 2022. On this scenario, Australia will be beyond 2023, perhaps in 2024 before we gain an opportunity to start increases in the cash rate and bring an end to our program of quantitative easing.

Conclusion

Quantitative easing in Australia has two major components. The first is that the RBA will continue to buy Australian Government three-year bonds. The second is that the RBA will continue to expand the Term Funding Facility to provide funding for lending for Australian banks.

Neither of these programs looks like they’re coming to an end before 2024 at the earliest.

Quantitative easing is now a long-term strategy of the Reserve Bank of Australia.

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