Who's the Government borrowing the money from to pay for Covid-19 response?

Monday, 17 August 2020

The economy has suffered a frightening fall as a result of Covid-19, and the Government is borrowing to support households, businesses, and spending.

ANALYSIS: The Government has been borrowing a lot of money to support households and companies through the Covid-19 economic crisis.

But where’s it borrowing that money from?

It’s a question Stuff readers have been asking, and economists Jarrod Kerr from Kiwibank, and Gareth Kiernan from Infometrics, say the answer is effectively our future selves, and our children.

But despite that, the risks of spooking the overseas private owners of the rest of New Zealand government bonds mean it’s too high-risk to simply cancel the debt.

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Government borrowing and spending has so far helped avoid a repeat of the Great Depression, says Jarrod Kerr, chief economist at Kiwibank.

In the May Budget, Finance Minister Grant Robertson unveiled a $50 billion spending package to be funded through the issue of government bonds.

WHAT’S THE BORROWING FOR AND SHOULD WE BE DOING IT?

Some of the money has been for the wage subsidy scheme. Some is for infrastructure projects. Some is to pay benefits.

“In theory, we’re borrowing from the future to plug [output] gaps today. We will have to pay it all back at some stage,” says Kerr.

“This is exactly what we should do in a recession. Quality investment today will enable us to pay back debt tomorrow. Reckless spending today will only burden future generations. We have an opportunity today, to address our creaking infrastructure, tackle climate change, and build a healthy, more productive economy for tomorrow.

The Reserve Bank is printing cash to buy government bonds.

“If I wake up in 15 years’ time, and my son, now 8 years old, spends over an hour on inadequate public transport to get to his first job interview, for a company he has no interest in, then we’ve failed him, and his whole generation.

“The healthier and larger the economy is, the more it can repay in the future. Leaving the economy the way it is, without fiscal support, is not an option. We have learnt from past recessions that if you don’t invest in downturns, you’re left with permanent economic scarring.”

WHO IS NEW ZEALAND BORROWING FROM?

In ordinary times, the government borrows billions of dollars from foreigners, local fund managers, insurers, banks and individuals, says Kerr.

“Foreigners owned over 60 per cent of New Zealand government bonds before the Covid-19 pandemic. But now the Reserve Bank has come into play,” he says.

“Through quantitative easing – basically printing fresh cash to buy government bonds – it was fast becoming the largest holder of government bonds.”

The Reserve Bank is targeting $100b of quantitative easing and will end up owning around 60 per cent of all government bonds, Kerr says.

The biggest buyer by far of new New Zealand government bonds is the Reserve Bank, says Infometrics’ chief forecaster Gareth Kiernan.

Already it owns around 23 per cent of government bonds, the Reserve Bank revealed in its latest Monetary Policy Statement, and it’s buying them at a rate of around $940 million a week.

Finance Minister Grant Robertson gives a Covid-19 financial report.

“The Reserve Bank is basically replacing the role of foreigners, and other local buyers,” Kerr says.

This ensures the government has to pay very little for its borrowing, and, he says: “The Reserve Bank is a friendly buyer. If the government was ever struggling to repay, the central bank would simply extend the programme indefinitely.”

This kind of in-country money creation and bond purchase scheme is happening in countries all over the world, says Kerr, including Australia, the US, and the UK.

WHERE’S THE RESERVE BANK GETTING THE MONEY FROM?

Kiernan says this is “more like printing money to spend rather than borrowing”.

In the first half of this year, total government debt rose from $85b to $114b, he says.

The Reserve Bank of New Zealand, headed by Governor Adrian Orr, is ‘printing’ money.

“Almost 70 per cent of this additional borrowing was funded by the Reserve Bank, with retail banks picking up the rest.”

“To the layperson, this fancy accounting can sound ridiculous. It looks like the central bank, which is a government institution, is simply creating money to allow another part of the government to spend it on wage subsidies or other Covid-19 policy responses.”

In normal times, printing more money leads to more inflation, Kiernan says.

“But these times are far from normal. Covid-19 has created a massive hole in demand that governments are trying to fill. Without the substantial policy response that we have seen, a repeat of the Great Depression and its persistent economic hardships would be likely.”

IF WE’RE BORROWING FROM OURSELVES, DO WE HAVE TO REPAY IT?

Kiernan acknowledges this leads to the very simple question of: “If the government is effectively borrowing most of this extra money from itself, does it really need to repay it in the future?”

The problem, he says, is the Reserve Bank cannot simply “forgive” its debt, because this would send dangerous signals about the remaining debt that is still held by the private sector.

It could, he says, indicate to overseas investors a country that’s taken the money-printing handbrake off, and they may demand higher interest to compensate for the risks.

“Any failure by the government to meet its obligations when the bonds mature would have catastrophic effects on its future ability to borrow,” Kiernan says.

But that does not mean there’s any hurry to repay the debt.

“However, the Reserve Bank could simply let the debt roll over. Central banks that undertook quantitative easing during the Global Financial Crisis have since barely reduced their government debt holdings. Globally, governments have been content to let the real size of the debt slowly be eroded by economic growth and inflation,” Kiernan says.

The debt does bring risks for the country, however, he says.

“Future risks lie around the re-emergence of faster inflation in coming years, accompanied by higher interest rates, which would drive up the cost of government debt.

“Nevertheless, that outcome would probably signal a strongly growing economy – one that could also withstand tax increases and tighter fiscal policy.”