Summary: RBA minutes reveal discussion of negative rates, financing fiscal deficits directly and indirectly; negative rates may limit credit supply, increase savings ratio; money creation comes at a cost, “no free lunch”;
The Reserve Bank of Australia left its cash rate and 3-year ACGB targets at 0.25% at its July meeting.
The minutes of that meeting have now been released. While they were largely a rehash of previous months’ views of international and local conditions, the “Considerations for Monetary Policy” section shed light on the RBA’s views regarding negative rates and the financing of fiscal deficits through central bank bond purchases, a practice advocated by proponents of Modern Monetary Theory (MMT).
“Members also reviewed the international experience with other monetary policies and their relevance in the Australian context, as they had done the previous year. These policies included negative interest rates, foreign exchange intervention, the purchase of private sector assets and also direct government financing.”
The European Central Bank was the first major central bank to introduce a negative interest rate in 2014. The Bank of Japan followed in 2016. In each case, what was seen as a temporary measure at the time to prompt economic growth has turned out to be a semi-permanent fixture. Both central banks introduced “asset purchase programmes” which indirectly fund government deficits.
Philip Lowes’ speech to the Annika Foundation added additional context on the policies mentioned above, especially negative interest rates and direct government financing.
With respect to negative interest rates, the RBA chief started off by stating “There has been no change to the Board’s view that negative interest rates in Australia are extraordinarily unlikely.” He said the main potential benefit of a negative rate was via downward pressure on the exchange rate.
However, he noted action of this sort came at a cost. “They can cause stresses in the financial system that are unhelpful for the supply of credit.” In other words, banks’ willingness to lend under these conditions may be reduced.
“They can also encourage people to save more, rather than spend more, so they can be counter-productive from that perspective, too.” Conventional economic theory implies spending as a proportional of income rises while saving falls as interest rates fall. However, recent research into household spending has suggested a point is reached where saving as a proportion of income begins to rise after interest rates fall. One explanation put forward is people forecast they will need to more savings to finance their retirements because the income they receive from their savings in a low interest rate environment will be lower than previously anticipated.