Lowe cautious on QE

Moves by the Reserve Bank to buy private assets or government bonds, known as quantitative easing, are unlikely in the near future, according to governor Philip Lowe.

Speaking at a recent Australian Business Economists dinner, Dr Lowe outlined how far the bank would be willing to loosen monetary policy to stimulate the economy.

The RBA reduced its cash rate from 1.5 per cent at the end of 2018 to be 0.75 per cent.

But negative interest rates were extraordinarily unlikely, Dr Lowe said, warning there might be a point where reducing rates would shake confidence and have a contractionary impact.

He said it was not clear experience with negative interest rates elsewhere had been a success.

Although Dr Lowe said they pushed down bond yields and exchange rates, there were other impacts.

“It has become increasingly apparent that negative rates create strains in parts of the banking system that can impair the ability of some banks to provide credit,” he said.

Buying private assets as part of a quantitative easing program was also not on the agenda.

Quantitative easing is when central banks buy government bonds or private assets through creation of new money.

It was particularly popular after the global financial crisis, and Dr Lowe said the six major central banks had lifted their holdings of securities from 5 per cent of GDP to nearly 30 per cent now.

But Dr Lowe warned such a move would insert the bank into decisions about resource allocation in the economy.

“While there are some scenarios where such intervention might be considered, those scenarios are not on our radar screen,” he said.

“If, and it is important to emphasise the word if, the Reserve Bank were to undertake a program of quantitative easing, we would purchase government bonds ... in the secondary market.”

Quantitative easing would only be considered at a cash rate of 0.25 per cent.

“The threshold for undertaking quantitative easing in Australia has not been reached, and I don’t expect it to be reached in the near future,” Dr Lowe said.

“In my view, there is not a smooth continuum running from interest rate reductions to quantitative easing.

“It is a bigger step to engage in money-financed asset purchases by the central bank than it is to cut interest rates.”

The economy was already benefiting from low rates, infrastructure spending, tax cuts and improved outlooks for resources and house prices, he said.

However, Dr Lowe acknowledged quantitative easing may be necessary if the bank believed the economy was drifting away from full employment and its inflation target.

Unclear impact

Reflecting on a recent report by the Bank of International Settlements, Dr Lowe said he found evidence about unconventional monetary interventions uncompelling.

“These extraordinary measures have continued way past the crisis period,” he said.

“In some countries, asset purchases have yet to be unwound and it remains unclear when, and even if, this will happen.

“So, a full evaluation is not yet possible.”

Dr Lowe said he was worried extensive use of unconventional tools could change incentives.

“It is possible ... (providing) liquidity reduces the incentive for financial institutions to hold their own adequate buffers, making episodes of stress more likely in the future,” he said.

There was also a risk excess monetary action would create an inaction bias in other policy instruments, like government spending, and concern low rates would allow unproductive ‘zombie’ firms to survive.

“There are also financial stability risks that can come from low interest rates boosting asset prices, and perhaps borrowing, at a time of weak economic growth,” Dr Lowe said.