At the onset of the COVID-19 pandemic and related health measures in 2020, the Reserve Bank of Australia (RBA) introduced a range of monetary policy measures to ensure funding costs remained low and credit remained available.
These measures included:
reducing the cash rate in March 2020 to 0.25 and to 0.1 per cent in November 2020;
the introduction of a target on the 3-year Australian Government bond yield of around 25 basis points;
the introduction of a Government Bond Purchase Program focusing on the 5-to-10-year segment of the yield curve;
providing a three-year Term Funding Facility (TFF) for banks and other authorised deposit-taking institutions; and
reducing the interest rate paid on Exchange Settlement (ES) balances (the balances the banking system holds with the RBA) to 10 basis points.
In assessing the broad macroeconomic picture, the RBA Governor (the Governor) explained that fiscal policy ‘has provided much of the support to the Australian economy’ and that this shift to using fiscal policy has been ‘a shock for a country that's got used to low budget deficits and low levels of public debt.’ However, the Governor – while painstakingly pointing out that fiscal policy is a matter for the government – provided four reasons behind this fiscal policy response:
borrowing today to support the economy avoids ‘an even bigger loss of output and jobs’;
Australia's public finances are in strong shape, and public debt ‘is much lower than in most other countries’;
the national balance sheet is ‘in a strong position after decades of good economic performance’; and
the Federal Government’s financing costs ‘have never been lower, with interest rates being the lowest since Federation’.
Since 2020, new COVID strains continue to affect economies and markets around the globe. However, considering the faster-than-expected recovery of the Australian economy, the RBA made decisions to unwind some of its policy responses to the pandemic:
On 3 November 2020, the interest rate on the TFF was reduced from 0.25 per cent to 0.1 per cent. Then, on 30 June 2021, the TFF closed to new drawdowns as scheduled.
On 1 February 2022, the RBA announced that bond purchases would cease after 10 February, and that it will maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent.
The RBA recently stated that it is too early to conclude that inflation is sustainably in the target range, highlighting that underlying inflation has only just reached the midpoint of the target range for the first time in over seven years.
Through the public hearing process, the committee closely examined the decisions of the RBA in the context of Australia’s broader macroeconomic conditions and assessed the RBA’s confidence in current monetary policy settings to support the Australian economy through a period of extraordinary uncertainty and unprecedented but necessary levels of pandemic-related deficit spending.
To boost the cash flow of businesses and the household sector and help Australia’s trade-exposed industries through the exchange rate, the RBA Board reduced the cash rate to 0.5 per cent on 3 March 2020, to 0.25 per cent on 18 March 2020, and to 0.1 per cent on 3 November 2020.
At the public hearing on 14 August 2020, the Governor told the Committee that the Board will not increase the cash rate until progress has been made towards full employment and it is confident that inflation will be sustainably within the two to three per cent target range.
The RBA acknowledged that low interest rates do have negative consequences for some people, particularly those relying on interest income. However, the RBA added that lower interest rates do benefit the community as a whole.
At the public hearing on 5 February 2021, the RBA was asked to clarify what it meant by ‘sustainably’ within the target range, to which the Governor responded that:
… we’ll see inflation at three per cent probably in six months time. That will be one quarter, so obviously that’s not ‘sustainably’. It really depends, as you are suggesting, on what’s going on in the economy. I’m expecting we’ll want to see inflation between two and three per cent for a few quarters and then there will be strong prospects that it’s going to stay there, and that will depend on what else is going on in the economy at the time.
More recently, as Australia experienced higher-than-expected inflation, the RBA told the committee at the public hearing on 11 February 2022 that it is too early to conclude that inflation is sustainably in the target range because in underlying terms, inflation has just reached the midpoint of the target band. The RBA also highlighted that this has come on the back of large disruptions to supply chains and distribution networks, with effects expected to only be temporary, and at a time when aggregate wage growth is no higher than it was before the pandemic.
Because of these circumstances, the RBA told the committee it is prepared to be patient and has ‘scope to wait and see how the data develop and how some of the uncertainties are resolved. Countries with higher rates of inflation have less scope to wait here’.
At the public hearing on 11 February 2022, the committee also asked the RBA what it thinks is the neutral cash rate, given the record high level of household debt. The Governor responded that:
I really hope that the equilibrium real interest rate, in those analytical terms, is positive. It’s going to deliver you an average rate of inflation of 2½, so if the real rate was zero that would be the cash rate of 2½. And we don’t know, but let’s hope productivity growth will be stronger and the return to savers will be positive in real terms. We don’t know. I’m hopeful, but we haven’t made up our minds on that. We’ll have to look at the evidence both here and globally.
When asked whether it could have handled communication around cash rate increases better, the RBA stated that it seeks to first, provide people with its forecasts for economic activity and inflation in the labour market and second, provide details of its reaction function – the factors that it takes into account when making decisions. The third thing it does is draw from the implications of those two things for the timing of interest rate changes.
In addition, the Governor stated that:
We have to provide people with forecasts and details of our reaction function. Whether it was wise to draw the implications of that for the timing of the increase in the cash rate I’ll let others judge but, from my perspective, the benefit of that is that it made it very clear to the community that the Reserve Bank was going to provide the support the economy needed …. As things have turned out better than expected, our forecasts have been revised up and, given our reaction function, that has changed the timing of the likely first increase in the cash rate.
Bond Yield Target
To help lower funding costs across the economy, on 19 March 2020, the RBA Board announced a 0.25 per cent target for the yield on 3-year Australian Government bonds. This target was then reduced to 0.1 per cent on 3 November 2020. The target was supported by RBA purchases of government bonds.
When asked whether the RBA would consider extending the yield curve control to a longer maturity, for example a five-year yield, the Governor stated that the Board chose a three-year bond rate as it ‘influences corporate and bank borrowing rates… by lowering the three-year bond rate, we lower the funding costs right across the country.’ The Governor added that he does not feel confident that ‘the cash rate is going to be where it is for five years’ and felt more assured to ‘start with the three and see where that goes and how the economy progresses’.
The committee asked whether an extension of the yield curve control would assist in moving inflation into the target band. The Governor stated that he is not confident that the RBA ‘would get much more traction at the moment from having the five-year yield curve at 10 or 15 basis points lower than where it currently is’ and added that if the RBA is going to have a target for a five-year yield, ‘it needs to be consistent with our expectations for the cash rate’.
On 6 July 2021, the Board announced that the yield target would continue to apply to the then-current 3-year Australian Government bond—the April 2024 bond—rather than roll to a later-maturity bond, and on 2 November 2021, the Board announced that the target on the April 2024 bond had been discontinued.
The committee asked why the RBA did not hold a board meeting when it decided to abandon the yield curve control, to which the Governor responded:
The sequence of events was that the CPI [Consumer Price Index] came out on the Wednesday before the board meeting on the following Tuesday. It came out and it was considerably higher than we had expected, and that followed a stronger labour market than we expected. We then spent some time reassessing the outlook of that for our forecasts and, on the subsequent day, the Thursday, we did contemplate the possibility of having a board meeting—I did think about it on the Friday—but the board was meeting just two days later on the Tuesday morning. We thought by the time we went through the process of setting up the board meeting and establishing the various considerations—we'd want it to be fully balanced—that we could wait until the Tuesday. In any case, if the board at that meeting on Tuesday had decided they wanted to defend the target, we would have gone in and bought the bonds again, and done our best to get the yield back to the target.
Government Bond Purchase Program
The Government Bond Purchase Program was introduced to help lower the whole structure of interest rates in Australia and to support the economy through the normal transmission of monetary policy.
On 3 November 2020, the RBA announced that it would purchase bonds issued by both the Australian Government and by the state and territory governments in the secondary market under a $100 billion bond purchase program.
The committee was interested in the state and territory government bonds purchasing program which was designed to ease financial constraints on state and territory budgets under pressure from falling GST, property and payroll tax revenues, and from high infrastructure borrowing.
When asked why the RBA had purchased a smaller share of state bonds in New South Wales and Victoria than their proportionate share of the population, the RBA explained that the aim of the program ‘was to counter the bond market dysfunction… in both the federal government and the semi-government markets… rather than fund the states in particular.’ The RBA added that:
What made sense for us is to calibrate it according to the stock of bonds outstanding as the more relevant metric. Certainly, investors typically don't hold bonds in proportion to something like gross state product; they're more likely to follow something which is weighted according to the outstanding stock of bonds. The shares that we ended up allocating to the different states—New South Wales and Victoria, with around 45 per cent of our buying program—were in accordance with the value of bonds outstanding...
In August 2020, the committee noted that the RBA was carrying around $50 billion of various government debts and could potentially agree to write off that debt to help the government through the COVID-19 period. The committee suggested that if the RBA insists on the government repaying its debts, it will have to borrow more and the RBA will have to purchase more bonds to meet the yield target.
The Governor explained that if the RBA tells the government not to pay the bonds back, ‘the central bank balance sheet is then hugely in negative territory… And, if you continue to do that, the central bank balance sheet would go more and more into negative equity, which would be very problematic in the end. It could destroy confidence in the country, and institutional arrangements would come under question’. The Governor added that ‘the right way to do this is for the government to borrow—at the lowest interest rate since Federation. The borrowing costs are not a constraint on government at the moment’.
When questioned whether the RBA had considered providing zero per cent interest loans to the government, the Governor stated that this does not ultimately lower the total cost of finance and ‘it can delay the time when the government ultimately pays for the cost of financing. It's certainly possible to do that and, in some circumstances, it could be warranted to do that. But they're not the circumstances that Australia faces’. The Governor explained that loans with a zero per cent interest rate mean that ‘the central bank has an asset that’s earning no money, and then, over time, there will be lower profits at the central bank and lower distributions to government, and there will have to be a tax compensation for that’.
On 2 February 2021, the RBA announced that it would purchase an additional $100 billion of government bonds following completion of the initial bond program in April 2021.
The RBA told the committee that it estimated its bond purchases had lowered yields on longer-term Australian Government bonds by around 30 basis points and also contributed to lower spreads on the bonds issued by the states and territories, while adding liquidity to the Australian financial system.
On 6 July 2021, the RBA announced that it would continue purchases of government bonds following completion of the second $100 billion of bond purchases in early September 2021, at a rate of $4 billion per week until at least mid-November.
On 1 February 2022, the RBA announced that bond purchases would cease after 10 February.
The decision to implement a bond buying program followed a careful review of international experience. Because other central banks have bought government bonds under quantitative easing programs, they have pushed down the yields on their bonds, which in turn, has put downward pressure on the value of their currencies.
The Governor told the committee that ultimately, across all the various programs, the RBA has purchased $350 billion of bonds issued by the Australian Government and by the state and territory governments. These purchases have lowered funding costs, supported asset prices, and led to a lower exchange rate.
Term Funding Facility (TFF)
On 18 March 2020, the RBA announced a Term Funding Facility (TFF) scheme for the banking system. This scheme would complement the target for the three-year bond yield and provide an incentive for lenders to support credit to businesses, especially small and medium-sized businesses.
Under the scheme, the RBA provided a three-year funding facility to authorised deposit-taking institutions (ADIs) at a fixed rate of 0.25 per cent, which was substantially below lenders’ funding costs. ADIs could obtain initial funding of up to 3 per cent of their existing outstanding credit until the end of September 2020 and could access additional funding if they increased lending to businesses, especially small and medium-sized businesses, until the end of March 2021.
On 1 September 2020, the RBA reviewed the operation of the TFF and ‘agreed that the TFF had worked as intended and, given the economic outlook, an expansion of the TFF was appropriate’. The RBA increased the size of the TFF to approximately $200 billion. ADIs could now access additional funding, equivalent to 2 per cent of their outstanding credit, at a fixed rate of 25 basis points for three years until the end of June 2021.
As at 3 November 2020, ADIs had drawn down $83 billion of low-cost funding through the TFF and had access to a further $104 billion under the facility.
From 3 November 2020, the RBA expanded the scheme further, with the introduction of additional and supplementary allowances. This reduced the interest rate on new drawdowns under the TFF to 0.1 per cent per annum, which could be accessed until 30 June 2021. The interest rate on existing drawdowns under the initial allowance, which closed to new drawdowns on 30 September, remained at the 0.25 per cent rate.
At the public hearing on 2 December 2020, the RBA was asked to give data on which institutions have been using the facility and how much those institutions have used of their allocations. The RBA responded in writing, outlining that as at December 2020, the total funding allowance under the TFF was around $190 billion, compared with $150 billion in August 2020 and $90 billion at the program’s inception.
Almost all of the funding available under the $84 billion TFF initial allowance was drawn down – the large Australian banks, mid-sized Australian banks and smaller ADIs drew down close to all of their initial allowances, with branches and subsidiaries of foreign banks using nearly three-quarters of their allowances.
On 4 May 2021, the RBA Board confirmed that it was not considering a further extension of the TFF.
Interest Rate for Exchange Settlement Balances
On 18 March 2020, the RBA announced that Exchange Settlement (ES) balances would be remunerated at 10 basis points, rather than zero. It explained that this would alleviate the cost to the banking system that, under the existing system, would eventuate from reducing the cash rate to 0.25 per cent.
Under the existing system, balances which financial institutions hold with the RBA earn an interest rate 25 basis points below the cash rate. With the cash rate set at 0.25 per cent, the interest rate on ES balances would be zero. The RBA explained that:
In view of the significant increase in the balances held in ES accounts resulting from the combined effect of the Bank's enhanced liquidity operations, bond purchases and the term funding program, maintaining a zero interest rate on these balances would increase the costs to the banking system. Members agreed that such an outcome would be undesirable in the current environment. They endorsed the proposal to alleviate this cost by increasing the rate of interest on settlement balances to 10 basis points.
On 3 November 2020, the RBA announced a further reduction in the cash rate to 0.1 per cent and a reduction in the interest rate on exchange settlement balances held by financial institutions at the RBA to zero.