Reserve Bank (RBNZ) Governor Adrian Orr admits lower interest rates benefit asset owners the most.
He made the acknowledgement when asked by interest.co.nz whether he was concerned the monetary policy tools the RBNZ is employing to meet its inflation and employment targets are benefiting those with debt, propping up asset prices and ultimately increasing inequality.
Orr recognised the situation, but explained the RBNZ was focussed on addressing the immediate challenge before it: high unemployment and a significant economic slump.
While low interest rates reduce savers’ incomes, Orr pointed out debt far outweighs savings in the New Zealand banking system. So overall, lower interest rates have a net positive effect.
From a financial stability perspective, Orr also said low interest rates improve cashflow.
But considering the side effects of the existing monetary policy model longer-term, Orr said, “You can reach these corner solutions where asset prices are so extreme, no one believes they are ever going to be held up, and you end up with volatility in asset prices.
“That is not our challenge, our purpose. We just have to be aware of that. And people, when they’re out making those investment decisions, have to be open-eyed, aware of those types of activities. It’s a global challenge.
“We are heading off the first and most important worst possible outcome, which is a significant recession, deflation. Deflation is terrible if you own debt because the real cost of that debt is rising every day.”
Preferable to employ a negative OCR and a term lending facility at the same time
The RBNZ on Wednesday expanded and extended its quantitative easing (QE) or Large-Scale Asset Purchase programme from up to $60 billion by May 2021 to $100 billion by June 2022.
It also said the next cab off the rank in terms of monetary policy tools it could employ were a negative Official Cash Rate (OCR), ideally coupled with a programme whereby it would lend to banks at a low rate to encourage them to lend to households and businesses at a low rate.
Given the RBNZ gave guidance it wouldn’t cut the OCR before March 2021, the question is whether it could forge ahead with the term lending facility before then.
Asked this, Orr said the “first best choice” was to employ the tools at the same time, but he didn’t want to “rule out optionality” due to the uncertain environment.
“To our best efforts we want to be able to have a very well calibrated, designed package of instruments,” he said.
“Not because we think QE… is reaching a limit. It’s simply that it’s better to have a combination of instruments that doesn’t put an over-burning pressure, or unanticipated distortion, on any one part of the market.”
RBNZ to work with banks to design lending facility
While some of the lending facilities the RBNZ has been providing banks since the onset of Covid-19 have been aimed at providing liquidity in the market, Orr said this facility would be aimed at keeping the yield curve, and thus interest rates, down.
Asked whether there would be conditions on the facility, like a requirement for banks to use the support to lend to certain businesses for example, Orr said: “[Banks] will be incentivised, as opposed to instructed to on-lend. This is why we’re talking about it so openly now, because a lot of that calibration and getting that right needs to be done with the banks themselves, and also with people like yourself [a journalist], so you can understand and put the transparency on the whole programme.”
Orr went on to explain how the facility could work: “As an example, you [a retail bank] could come to us. You could get your term loan. But you’ll get top-ups or replacements as a function of what you’ve actually on-lent. And so that’s an incentive to be on-lending, rather than just stocking up your retail bank balance sheet with this cheap funding, at the cost of other forms of funding.”
Orr said the RBNZ was fortunate to be in a position to look at what other central banks are doing, and work with retail banks on a programme.
Too early to tell if a higher bond-buying cap would be distortionary
Coming back to QE, Orr said news of community outbreak of Covid-19 in New Zealand had “no immediate impact” on the quantum of New Zealand Government Bonds the RBNZ committed to buying, nor the pace at which it would buy them.
“We want to be at least keeping pace, if not out pacing the debt issuance,” Orr said.
“The pace is not about drawing a straight line between now and June 2022 - it is simply the length of the indemnity we have. The pace is going to be a function of the impact we need to have on interest rates.”
The Finance Minister agreed to allow the RBNZ to buy up to 60% of the New Zealand Government Bonds on issue through its QE programme. This cap previously sat at 50%. Increasing it enables the RBNZ to “front load” its bond buying, reducing the risk of it running out of bonds to buy.
Orr said it was too early to tell if enabling the RBNZ to buy up to 70% of the bonds on issue, for example, would create too much of a distortion in the market/crowd out other investors.
He commented: “Very often the New Zealand debt market is flow-driven, so the weekly level of purchases will have quite a significant impact - up or down - on interest rates. So it’s not just the end level, it’s the pace at which we are doing it.”
See the video interview for more on the RBNZ’s latest monetary policy decision. For those interested in Modern Monetary Theory, Orr shared his thoughts on this towards the end of the interview.