Large scale asset purchases remain 'in our toolbox for specific circumstances of extreme economic turbulence,' RBNZ's Paul Conway says

While the Official Cash Rate is still the preferred tool to influence monetary conditions in extreme events like the Covid-19 pandemic, the Reserve Bank’s chief economist says there’s always going to be a need to have the option of large scale asset purchase (LSAP) programmes. 

“Once that Official Cash Rate hits its effective lower bound, where it can’t go any lower and that might slightly be negative - you can have a negative Official Cash Rate but not massively negative. So there will always be an effective lower bound. [So] we think there’s always going to be a need to have LSAPs in the toolkit of the Monetary Policy Committee for extreme economic crises such as the pandemic,” Reserve Bank (RBNZ) chief economist Paul Conway says. 

Conway's comments on Wednesday follow his speech on the use of alternative monetary policy tools at a Citi Australia & New Zealand Investment Conference. 

Alongside the speech, new research was released which assessed the costs and benefits of the LSAP used in 2020 and 2021 as monetary policy stimulus after the OCR was cut to a record low of 0.25%.

The LSAP programme, or quantitative easing (QE), saw the Reserve Bank buy about $53 billion of Government and local government bonds from private investors to lower long-term interest rates and support borrowing during the pandemic. This decision was widely criticised after the Bank hiked rates to fight inflation, crystallising losses on its bond portfolio of roughly $10.5 billion.

Conway says it did cost a lot in terms of mark-to-market losses from the LSAP programme. Mark-to-market losses are unrealised accounting losses that happen when the current market value of an asset goes below its original purchase price.

“So the Reserve Bank bought the government bonds at scale to provide additional monetary policy stimulus once the Official Cash Rate hit its effective lower bound. And what I will say about those losses is that they’re very easy to quantify and they’re very easy to see … But the benefit of LSAPs is harder to see and harder to get a handle on."

I think one of the most obvious benefits that you can see is that LSAPs kept wholesale financial markets operating over the pandemic," he says.

“What we find is LSAPs, as pretty much anticipated by the Monetary Policy Committee at the time, they did lower longer term interest rates which got the currency to depreciate a bit more than it otherwise would. And they did generate additional economic activity which in turn, did stimulate tax revenue for the government.”

Conway says once those broader effects were taken into account, the increase in tax revenue largely offset those mark-to-market losses. 

“I should say this is based on one model. This is just where we’re at. It’s not the last word, but it’s where we’re at.”

When asked if the central bank would consider LSAPs in the future if there was another pandemic-like event, Conway says “that’s absolutely where we’re at currently”.

But LSAPs are not a day-to-day thing, he says. 

“You don’t just reach for your LSAPs when you want to stimulate your economy. You use the OCR for that. But in extreme conditions, our research to date shows that there’s clearly a need for having the capability to do LSAPs.”

Conway says LSAPs weren’t a perfect tool for monetary policy as there’s issues, for example, with the effect they have on inequality in an economy, but; “we think, on balance, we need to keep them in the toolkit for extreme macroeconomic turbulence”. 

Reflecting on the research, he says he's pleased to get it out.

"The Covid response from fiscal and monetary policy was large. It was a full on economic storm ... It's really important that we review what happened and evaluate our actions and figure out what we do differently next time around."

“I don’t know if we’re going to have a pandemic anytime soon, but it’s a volatile global economy out there currently," he says.

In terms of international comparison of central bond bank purchases over the Covid-19 pandemic, New Zealand was "well below the OECD average", he says. 

"It was also the first time we've used quantitative easing in New Zealand so this is consistent with what I was saying before - we think it has a place in our toolbox for specific circumstances of extreme economic turbulence."

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