For the first time ever, the RBA has introduced ‘quantitative easing’ as a component of its monetary policy in March of 2020 as a way to support the efforts of macroeconomic policy to curb the COVID-19 recession. Quantitative easing is an unconventional form of monetary policy which involves the RBA printing money to create cash reserves and using these reserves to purchase bonds and other securities from the bond market.
This has attracted a lot of discussion within the media concerning the validity and potential ramifications of quantitative easing in light of fears surrounding the economic concept of ‘Helicopter Money’, and whether quantitative easing will lead to hyper-inflation which has been observed in numerous countries such as Venezuela and Zimbabwe. Whether these fears are true will be explored below.
The RBA’s current mechanism of ‘printing money’ does not actually involve the Mint and the creation of physical currency, but rather, the plugging of numbers digitally on computer trading screens to increase the amount of cash available to the RBA on their balance sheets. Digital rather than physical per se. This is actually extremely different to what Milton Friedman called ‘helicopter money’, a phrase which has garnered a lot of attention recently which is rooted in a fear that the RBA are simply handing out money created out of ‘thin air’. However, helicopter money involves the central bank distributing the newly printed money to the public, and this is clearly not the case.
The RBA are currently purchasing government bonds in particular as government bonds are considered to be comparatively low risk than other securities. They are considered low risk investments because the likelihood of the government not repaying its loan and thus defaulting is incredibly low, especially considering the credit rating of the Australian government being AAA (although with a negative rather than stable outlook as of April 2020).
It is important to note that although it is government securities being bought, the RBA is not directly giving money to the government. This is due to the following chain of purchases; the government issues bonds which are then bought by banks and other private institutions, and the RBA buys these bonds from said banks and other private institutions. Private institutions acting as an intermediary in this way helps promote central bank independence in light of a policy move which could easily blur the lines if left to its own devices.
The cautionary tale of quantitative easing lies in the theoretical argument that printing money causes hyper-inflation. If money supply is increasing faster than the real output of an economy, if all else remains equal, inflation is incurred because the higher volume of cash chases the same number of goods which thus prompts firms to raise prices.
However, this is unlikely to occur within the current economic climate despite the printing of money simply because other measures of money supply such as M2 and credit remain subdued and further, high spare capacity as reflected in the rising unemployment rate places downward pressure on wages and thus cost-push inflation. In a more general reason as to why this is unlikely to occur, Australia’s already low inflation rate pre-COVID, which dipped below the target range of 2-3% during 2019, also cushions the phenomenon of hyper-inflation.
Quantitative easing has the ability to increase economic growth in two ways; stimulating spending by financial institutions and lowering the interest rates offered by the said institutions.
In the RBA using their reserves to purchase bonds from financial institutions, this provides institutions a greater capacity to either invest themselves or give out loans to individuals and households, hence increasing either the investment component of the aggregate demand equation or the consumption component [AD = C + I + G + (X-M)].
Furthermore, when banks have greater funds and thus a greater capacity to give out loans, individuals and households have a wider selection of banks to choose from regarding which one they will take out a loan with. This increased competition places downward pressure on interest rates, which subsequently encourages investment and spending and has the same effect on the aggregate demand equation as seen in the above paragraph.