Weaning New Zealand off financial heroin
Tuesday, 22 February 2022
Dileepa Fonseka is a Stuff writer on business and politics.
OPINION: Hotel California should be the Reserve Bank’s on-hold music of choice when it fires up its livestream for a monetary policy announcement on Wednesday.
Along with raising the official cash rate, Reserve Bank governor Adrian Orr is expected to outline how the Reserve Bank might wind back quantitative easing (QE).
And Fisher Funds’ head of fixed income, David McLeish, likens QE to that infamous hotel the Eagles sang about: easy to enter, but difficult to leave.
The song is seen as a metaphor for how hard it is to kick a heroin habit, which makes the soundtrack even more appropriate because TOP (The Opportunities Party) leader Raf Manji’s metaphor of choice for QE is heroin itself.
**READ MORE:
* Quantitative Easing: An Obituary
* What can central banks actually do about inflation?
* Infrastructure and housing could still be handbrakes in a post-Covid world
* Covid-19: Why the government can’t simply cancel its pandemic debt by printing more money
**
Interest rates are a useful tool to smooth out booms and busts, and when the economy looks like it is about to experience a profound economic shock (for instance, a global pandemic that could wipe out a chunk of your population), you typically cut rates to encourage people to spend, invest and borrow during a downturn.
However, interest rate cuts get less effective the closer you get to zero. So you bring in QE as well. The theory is you create money and use it to start buying government bonds, which sends the people who would normally buy bonds storming into riskier assets like property and company shares.
It also safeguards a government’s ability to borrow during a liquidity crunch.
In the immediate aftermath of the global Covid-19 lockdowns Government borrowing froze because market players were unsure how to price government debt, and it led to instability in other debt markets which use the price of government bonds as their benchmark.
The Reserve Bank’s (RBNZ) last annual report says its holdings of government securities now run to $57.5 billion. In January, the total of government debt securities on issue sat at more than $158b.
Which means the Reserve Bank owns roughly a third of all government debt, which makes it tricky to sell down those bonds quickly without causing further chaos.
When the US Federal Reserve tried backing out of QE in 2013 it sparked a market panic colloquially referred to as a “taper tantrum”.
Yet for its multibillion-dollar price tag, and lofty aims, does QE actually achieve anything useful? McLeish argues it does not:
“The evidence, for me, is very inconclusive as to the impact that it really has on meeting central bank goals of full employment and stable prices, or stable inflation.
“I've studied this a lot over many, many years in many countries and I still can't find any conclusive evidence.
“I think it does help in very stressed situations, but we're not in a very stressed situation.”
Funnily enough, an academic paper headed Fifty Shades of QE found the researchers who were most likely to find successful outcomes from QE were those employed by the central banks doing the QE.
With scepticism about the usefulness of QE growing, some have suggested selling down those bonds to tighten monetary conditions.
In doing so, you would also realise bond losses in their billions (because rising interest rates have reduced the value of the bonds the RBNZ bought), all indemnified by the taxpayer.
McLeish sees the advantage of this in helping the bond market return to normal, but his scepticism about QE extends to quantitative tightening (the selling down of government bonds held by the Reserve Bank) too, and he suspects QT won’t really do much to cool the economy either.
Amid all the opaqueness, Manji says the Reserve Bank has an opportunity to add a much higher level of transparency to the whole debate, and should focus on three questions: whether it is easier to drop interest rates rather than engage in QE; whether there are other ways of dealing with liquidity in financial markets; and whether QE is actually a good way to fund government borrowing.
Of course with QE falling out of favour that sends us right back to where we started: interest rates.
Central banks around the world are now raising rates. The RBNZ is expected to raise them by 25 basis points on Wednesday. Manji, who in the past has advised investment banks in London on macroeconomic issues, suggests it raise the rate by even more (50 basis points) to cut off the need to lift them further in future.
The rise in interest rates, and the ending of QE, means the “build back better” window for governments to borrow at low interest rates, to invest in infrastructure, is also rapidly closing, if it hasn’t already.
“I think that opportunity has been reduced, and is probably reducing by the day,” McLeish says.
“The harsh reality is that the part of the economy that decided to take advantage of those low interest rates were households, and what did they do with it? They bought bigger houses.”
Some drugs are just too hard to kick.