The Old Lady of Threadneedle Street, alias the Bank of England, is “a little bit pregnant” in a move that presages pressures ahead for our central bank – and considerable risks for the eventual stability of our economy.
On April 5, the governor of Britain’s central bank wrote that the BoE was not and would not indulge in “monetary financing” – that is, directly funding government spending.
By the end of that week, it was.
Oh, but only a little bit, the bank insisted. It would be “temporary and short term”. Only a little bit pregnant indeed.
And the British government, while allegedly only putting the financing mechanism in a little bit, nonetheless had deflowered the central bank – its independence and control of monetary policy no longer virginally pure.
If it chooses to go further next time it has the fiscal urge, it will be so much easier.
As Martin Wolf explained in the Financial Times, the UK Treasury now controls what happens with the mechanism of the BoE buying bonds directly from the government.
Our central bank is also “printing money” – quantitative easing – by buying Australian government bonds, but it is doing so in the secondary market – buying bonds owned by banks and other institutions.
The difference between buying bonds directly and indirectly might seem like splitting hairs, but it is considerably different and matters a great deal if political pressures down the track were to make the government more ambitious about spending.
The Reserve Bank has learned from other central banks’ mistakes with QE.
It is specifically intervening – buying scores of billions of dollars worth of bonds – with the target of keeping the three-year bond rate about the same as the cash rate, 0.25 per cent.
During the GFC, other central banks announced amounts of bond buying – thus providing less policy certainty and surrendering the threat of their balance sheet being used to ensure their goal.
Operating in the secondary market maintains a price signal about government borrowing and creditworthiness – it helps keep the government honest.
And it helps avoid the temptation inherent in a central bank directly financing government spending by printing money – that the federal government’s appetite for spending runs amok.
That way Zimbabwe lies.
An accounting sleight of hand
The temptation is still out there and it will grow as: (A) the federal government is pushed into further safety net and stimulus spending; and (B) the debt chickens come home to roost as the immediate crisis recedes, leaving the government more than a trillion dollars in the red with a weak economy and the remnants of its decade of anti-Labor political debt sloganeering.
Faced with a mountain of debt, the temptation will be strong to “monetise” it – pull an accounting sleight of hand with the RBA to make it effectively disappear.
That battle is likely to be faced first in the countries with vastly greater government debt than Australia.
There are a number of points on a scale of Australia being at one and Zimbabwe 10.
Here, the pressure will come on the politics of facing up to the debt.
That’s already to be seen in the common questions about how the debt will eventually be repaid, questions that receive brave answers from a government that is still struggling to grasp issues today without bothering too much about tomorrow.
If a government didn’t want to waste a good crisis, it could be the excuse for the genuine everything-is-on-the-table tax reform that would offend every interest group but yet be better for the nation.
Or it could be the excuse for doctrinaire small-government, trickle-down policy failure that would damage the country for generations.
With that future and the next round or rounds of big government spending announcements (yes, Virginia, there will need to be more), the temptation will grow to pull an accounting swifty with the complicity of the RBA.
How it would work
The first step would be, like the UK, including at least an element of direct monetary financing – the RBA buying bonds directly from the government, pumping new money directly into Treasury.
The much bigger step would be the government designing “special” bonds for the RBA to buy – bonds that carried minimal or no interest, that would be non-tradable and designed to be never redeemed.
Such special bonds would not fluctuate in value and thus would not impact the RBA’s profit and loss account.
The bonds would sit on the RBA’s balance sheet as an asset while the money it gave to the government would be a liability – each effectively cancelling each other out in the greater scheme of blurring the lines between what is government and what is the government’s central bank.
At some future point, with a little accounting imagination, the whole transaction could be cancelled.
To some, such a policy baby sounds like a saviour, but to others, it’s a dangerous monster.
On the monster side, printing a large amount of money is inflationary. At some point, it is damagingly inflationary.
Combine that with the loss of hard-won central bank independence and credibility, and it means starting the battle against inflation all over again.
Damaged central bank credibility means higher interest rates in the market place and loss of confidence in the currency.
And then there’s the little matter of politicians becoming addicted to an apparently easy solution once the central bank has lost any semblance of independence. That way Zimbabwe really does lie.
The case for ‘monetary financing’ in Australia
Former NSW Treasury secretary, Professor Percy Allan, is on the saviour side.
He would like the government to sell zero-coupon perpetual bonds to the RBA so that taxpayers never have to stump up the money or even interest on the debt.
He paints the scenario of the RBA purchasing $200 billion worth of such bonds to fund stimulus, thus boosting broad money supply by 10 per cent.
“The RBA only needs normal bonds (at market yield for a set maturity) if it needs to sell them in future to reduce money supply by the same amount,” Professor Allan writes.
“Given that we are going into a depression (fall in GDP of 10 per cent) and the next decade will be a period of deleveraging following the debt binge of the last decade, that prospect seems remote.
“And in any case the RBA has other mechanisms to rein in money supply (e.g. minimum bank reserve requirements).
“It’s possible the massive direct and indirect bond buying program by central banks during this crisis will end with governments legislating to expunge their associated liabilities.
“Or they will insist the interest paid on these bonds be returned by central bank as dividend payments. Either way the debt effectively would be monetised.
“I just don’t see taxpayers meeting this bill for emergency measures given that increased taxes will be needed for funding fiscal pressures related to demographic and other factors.
“Do we really think Morrison or his successors will ever announce a tax or austerity plan to repay the $200 billion or meet the $2 billion a year in extra interest payments when the RBA does not need the income?”
It is a radical proposal, one that neither the RBA or government wants to explore at present, but policy is evolving very rapidly.
The case against
As one former member of the official family put it: “We have had a radical monetary policy statement and three fiscal statements in a month – of modest, large and huge proportions.
“I suspect that, in the bureaucracy, about five years of macroeconomic debate has been condensed into the period of about a month. Legendary, career-defining reputations will have been made.
“It is possible further major decisions will come; I think that will depend on how the world economy and financial system unfold. There are large risks.
“But before long, attention will turn to the issues that will be relevant in the post-corona world. In their own way, they will be just as hard.
“I doubt an economy can hibernate and wake up to a world like it was when it went to sleep. Morrison will need all the political capital he is currently accumulating.”
Last year’s BlackRock paper on “helicopter money” that I’ve referenced here before warned of the clear and present dangers of monetary financing, but it also made the case for it perhaps being both necessary and manageable in the next crisis.
We are in that “next crisis”.
And everyone knows you can’t be “a little bit pregnant”.