The Reserve Bank has created $30b in new money out of thin air. Here’s how


Australia

There’s a big garage door very close to the corner of Martin Place and Phillip Street in Sydney’s CBD.

If you stand on the other side of the street long enough you’ll see an armoured truck, with a large police escort, pulling into the driveway.

It’s like a scene out of the Italian Job, but it’s actually a pretty standard Reserve Bank procedure — the truck is delivering cold hard cash to the central bank.

That’s the image you might summon when you think of the Reserve Bank printing money: a truck chock-full of cash arriving from the Mint with brand new money, the Reserve Bank unloading it and then pushing that money out into the economy.

But now the Reserve Bank is creating money out of thin air instead.

It’s literally creating the money on computer screens.

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Reserve Bank confirms ‘money printing’



Photo:

Governor of the Reserve Bank of Australia Philip Lowe. (ABC News: John Gunn)

In recent weeks the Reserve Bank has been buying government bonds. It may do this via an agreement with one of the big four banks, or maybe with a fund manager — anyone that has been holding the bonds in bulk.

It’s been doing this by “expanding its balance sheet”.

It sounds technical but it’s actually really simple.

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Most households have a budget. And if you wanted to, you could create your own balance sheet. Your car would be listed as an asset and your credit card debt would be a liability.

The thing is, your cash is fixed. You have income coming in every fortnight or every month and, unless you get a pay rise, it doesn’t change.

What if, however, you could create money? You’d just sit at home, go to your balance sheet and change your $10,000 in the bank to $100,000. Easy. You could buy more stuff then using your debit card — no need to print your own money.

This is what the Reserve Bank has now done.

In its explainer on Unconventional Monetary Policy the Reserve Bank says:

“Asset purchases — also known as quantitative easing (QE) — involves the outright purchase of assets by the central bank from the private sector with the central bank paying for these assets by creating ‘central bank reserves’.

“This has been popularly referred to as ‘printing money’.”

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Reserve Bank wrestling all interest rates onto the floor

Now that the Reserve Bank has a licence to print money, it is going into the three-year bond market and buying up bonds.

I understand this might sound incredibly dull and irrelevant, but it’s actually quite interesting.

You see the Reserve Bank is now buying billions of dollars of government bonds from the commercial banks.


Infographic:
The Reserve Bank has now injected over $30 billion into the economy through its purchasing of government debt.
(Supplied: RBA)

This is what’s known as buying bonds in the secondary market.

If the RBA bought bonds directly from the Government it would, in effect, be directly funding the Government. And that’s clearly not on.

So how does this affect me?

As the Reserve Bank buys up government bonds their price goes up and the yield, or interest rate, on those bonds goes down.

This means the Reserve Bank can influence the interest rates on three-year government bonds. This in turn lowers the interest rates on other debt securities.

The Reserve Bank has said it is targeting three-year bonds in the hope of lowering the entire regime. But it has said it will buy across the spectrum of bonds too.

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The 10-year rate is the common benchmark or risk-free rate. That’s still elevated, but about half what it was midway through March.

The Reserve Bank has already bought tens of billions of dollars of bonds, but by the time it’s finished, both variable and fixed rate mortgages, as well as business loans of all shapes and sizes, should all be even lower than they are today, and, most importantly, will remain low for years.

It will have also give the Federal Government a once-in-a-generation opportunity to splurge on the economy at obscenely low interest rates, to help pay of things like the JobKeeper payments.

This is because it’s government debt that the Reserve Bank is ultimately making cheaper by buying its bonds.

Reserve Bank’s cash rate setting becoming tricky

There’s also another highly unusual phenomenon taking place right now.

RBA slashes interest rates to 0.25pc
The Reserve Bank cuts interest rates to a record low and announces a quantitative easing program for the first time in its history to help prevent a coronavirus-driven recession.

The Reserve Bank meets every month (apart from January) to announce the rate at which it’s going to set the cash rate “target”.

Reserve Bank representatives literally buy and sell securities at the bank’s headquarters in Martin Place on a daily basis to ensure the cash rate, or overnight money rate, sits at roughly 0.25 percentage points (where the cash rate currently stands).

But HSBC has told the ABC that on several days in the past few weeks, the cash rate has actually dropped much lower than that.

This won’t lead to a drop in your mortgage repayments, but it does give you a sense of the rough and tumble in the money markets right now.

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The bottom line

The point of all this is to ensure the Federal Government can borrow more than $200 billion as cheaply as possible, and that businesses can pay back money with more ease.

It’ll also ensure mortgage repayments, for those who are not on a repayments break, are as low as they can feasibly be.

One constant in all of this though is that the Reserve Bank hasn’t changed the rule of when it will start raising rates. That will happen when Australia reaches full employment (set at roughly 4.5 per cent).

You can see why EY, AMP Capital, the NAB and HSBC all think record low interest rates are now likely to be with us for a considerable period of time.

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Source: https://www.abc.net.au/news