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Quantitative easing is surely driving down interest rates and in time will most likely lead to inflation. Whether it will stimulate the economy is much more problematic

Quantitative easing is surely driving down interest rates and in time will most likely lead to inflation. Whether it will stimulate the economy is much more problematic

The current policy of the Reserve Bank is very clear. It is to reduce interest rates. The underlying theory, or perhaps ‘notion’ is a better term, is that low interest rates will stimulate the economy, either directly by stimulating investment, or indirectly by stimulating inflation.

To the extent that there is evidence to support this notion about low interest rates, that evidence is opaque and even then comes from times very different to the current situation.    

It started with the Phillips Curve

There was a stream of economic work, starting with the Philips Curve of the late 1950s, that showed that unemployment rates were inversely related to inflation, at least in the short term. The empirical data was clear but that evidence was atheoretical. It did not prove what was cause and what was effect.

Subsequently, Milton Friedman, Robert Solow and others developed a theoretical framework that purported to show that in the long-term inflation was ineffective in raising employment. It was Friedman who invented the term ‘stagflation’. Subsequent events did seem to prove, at least on this point, that Friedman was correct. Of course, Friedman remains controversial in relation to some of his other work and perspectives.

Despite the lack of evidence that modest inflation is good, the notion remains embedded within monetary policy both in New Zealand and overseas. All of the Central Banks in the Western World beat to the same drum despite the lack of evidence. In New Zealand, the Reserve Bank is supposed to try and keep inflation between 1% and 3% and aiming generally for a mid-point of 2%.

New Zealand was the first country in the world to explicitly target inflation through its Central Bank. That was in 1998. At the time it was widely perceived as a tool to keep inflation down. The notion that inflation could be too low as well as too high seemed of little relevance back then.

More recently, the Reserve Bank has also been required to keep in mind the need to minimise unemployment. That in effect also reinforces the conventional wisdom from more than 50 years ago that low interest rates combined with some inflation were important for economic growth.

For many years the main weapon of the Reserve Bank was the official cash rate (OCR), this being the rate that the Reserve Bank pays on money that the broader banking system holds at the Reserve Bank. In theory this OCR only has a direct impact on very short-term rates but it also has a strong messaging element, as well as an indirect influence through into the longer-term yield curve.

I recall a seminar I attended about ten years ago, perhaps a little more, where a very senior official of the Reserve Bank acknowledged, under Chatham House Rules, that the OCR could only be effective within very constrained limits determined by where the broader market wanted to go. He acknowledged that the OCR would lose credibility as a tool if it travelled too far away from the views of the broader market.

Quantitative Easing

During these last ten years there has been increasing use internationally of the so-called unorthodox policy instrument called ‘quantitative easing’. In essence it is a policy implemented by Central Banks to put more money into the economy through money creation. It is intended to lower interest rates, bring about modest inflation, and stimulate investment.

Although the term ‘quantitative easing’ only came into the lexicon within the last thirty years, the concept has been around for a very long time. Various South American presidents were well versed in it by the 1970s and President Mugabe of Zimbabwe also saw it as the honey pot policy. During the inflationary times of the 1970s and 1980s, the New Zealand Government was also adept at increasing the supply of money, although without the exuberance that some others showed.

In those pre-digital times, it was all done via the printing presses. Now all it requires is entries in electronic ledgers.

In times of crisis such as the present, there is clearly a role for some level of quantitative easing. It helps the Government deal with a huge deficit, where its expenditure is much greater than the taxes that are coming in. But the question has to be around the balance.

Right now, there can be little doubt that quantitative easing is contributing to declining interest rates.  The policy is very effective in that regard because it is helping to create a flood of capital looking for a home. It is all about supply and demand.

These exceptionally low interest rates have to be good news for mortgage holders who are paying less interest. Unfortunately, it is not so good for those who are funding those mortgages by their fixed deposits at the banks. Nor is it good news for those who are still trying to get on the property ladder. Some would say it is contributing to the financial craziness of the world we find ourselves in.

Central Banks seem particularly slow to recognise that once interest rates get close to zero people do not actually save less. Rather, excessively low interest on savings leads people into a state of concern that they need to save more as the rainy day threatens to turn into a destructive storm.

I hope that the Reserve Bank has a research programme to better understand these human behaviours. They certainly won’t learn anything from their econometric models that reflect a time when things were very different to now. The possible exception would be to reflect more deeply on the experience of Japan in the last three decades since its economic bubble burst.

I know that in my family, and many of the people I talk to, we are now looking more closely at expenditure. This is linked to the ongoing decline in interest on fixed deposits. If everyone in New Zealand does that then the economy is going to tank and unemployment will rise more than otherwise.   

Conversely, I know of no-one who is encouraged by the low interest rates to undertake more investment. The entrepreneurs that I know are saying predominantly that this is a time to sit tight. In any case, the banks are not interested in anything that has an element of risk.

Tradables versus non-tradables

Headline inflation is currently very low but that is only because of so-called ‘tradables’. These are the items that are tradable across international borders, and for which there is a corresponding ‘world price’ mediated only by trading barriers including logistical costs.

Right now, with the New Zealand dollar strengthening in recent months, linked at least in part to the enviable situation that New Zealand is in with respect to COVID compared to most of the world, the inflation rate in tradables is indeed negligible. However, with all of the world engaging in quantitative easing that is unlikely to remain the situation.  Also, independent of any quantitative easing, international oil prices are not going to stay this low in the long-term.

Scratch below the surface of the headline data for inflation and it is readily apparent that there is significant inflation for non-tradables under way, currently at slightly above 3% over the last year.  These are the items such as rates and many of the services supplied ‘by New Zealanders to New Zealanders’. These non-tradables are already suffering from stagflation.

Financing Government deficits

In arguing for the brakes to be put on quantitative easing, that is not necessarily to say that the Government needs to slow down on its own expenditure, be that on infrastructure or essential needs in social welfare. That is a separate issue. My focus here is not on the expenditure itself but how should the appropriate expenditure be financed.

When Governments run deficits, with expenditure exceeding taxation income, then somehow those deficits have to be financed. The standard way that Treasury does this is by issuing of bonds which are purchased by the financial institutions using their reserves.

As long as the Reserve Bank does not intervene through itself purchasing these bonds, then the bonds will stay in the market and interest rates on retail savings by citizens will rise. That may well be the necessary precursor to the building of some consumer confidence among savers that they can think about spending again.  A return on fixed deposits of say 3% per annum might well be enough to change attitudes, as long as inflation is low.

In contrast, what is happening right now is that the Reserve Bank is sucking these bonds out of the market. The Reserve Bank funds this with digital money that it creates.

In the magic financial world of bank ledgers, everything balances with countervailing entries, but let there be no doubt that the first and key stage of money creation has occurred.

From the perspective of the commercial financial institutions, two things have happened. First, they have purchased bonds from the Treasury using their own bank reserves. Second, these bonds have then been transferred via the secondary market to the Reserve Bank, collecting an intermediation fee along the way. The reserves that the commercial institutions initially used to purchase the bonds from the Treasury have now come back into their institution accounts at the Reserve Bank.

From the perspective of the Treasury, they now have the funds to run the Government, balanced by a liability to the Reserve Bank which holds the bonds. So, in terms of where the created money has ended up, it is now with the Treasury.

If we think of the combined entities of the Treasury and the Reserve Bank, which we will call ‘the State’ then the payments of interest on the Treasury bonds by the Treasury to the Reserve Bank are internal transfers.  Overall, it costs the State nothing.

Of course, this apparent magic can never be the full story. The key issue is whether the newly created money has really been used by the Government to turn unemployed resources into productive resources. Otherwise we have more money chasing the same amount of goods and that is the definition of stagflation. And that means that everyone in the economy, except perhaps those who are firmly aboard the pumped-up leveraged property market, is bearing the cost.

The question therefore in the current situation, is not whether or not the concept of quantitative easing is right or wrong, but how much quantitative easing is appropriate and how much of the Government deficit should be left in the market to be funded by private savings. The related question is how large a deficit should the Government be running in an effort to reduce unemployed resources. And that raises the questions as to the specific projects that will indeed use unemployed resources rather than fighting for resources that are already being used in the private economy.

Earlier in this article I said that quantitative easing by the Reserve Bank represents the first stage of money creation, leading to the Treasury being funded by money which has thereby been created. But of course, this too is not quite the full story. What happens if the trading banks get nervous about lending and allow their own reserves at the Reserve Bank to build up? This is important because it is exactly what is happening right now, driven by money pouring in from citizen savers.

The consequence is that there is a lack of credit to potential borrowers, driven not by a lack of liquidity but by perceived risk. Also, banks attempt to minimise their lending risk by maximising their interest rate margins. The consequence is that in the short term at least the reduced economic activity will hold any inflation at bay.

However, this constraint on inflation is only temporary, lasting for as long as the recessionary forces are dominant. Once COVID is eventually overcome, then the inflationary forces will truly be unleashed as banks once again use their augmented reserves to create credit which multiplies its ways through the system.

Getting the balance right

So, the question comes back to how much quantitative easing should the Reserve Bank indulge in.

My current perspective is that they are indulging in too much and that this is leading to more saving and less spending by those who rely on fixed deposits for their income. Also, despite the increased savings behaviours, there is no appetite in the commercial sector for genuine investment. All we seem to be seeing, pumped by quantitative easing combined with an exceptionally low OCR, is a flight to the ponzi-style share market and the long-term safe haven of property.

In all of the above I have largely looked at New Zealand as if we New Zealanders are in control of our own future, either directly through our private decisions or by decisions made by Government on our behalf. One key simplification is that I have thereby ignored that New Zealand has an open financial system with funds sloshing in an out as the global financial wizards from afar try to maximise benefits for themselves.

If New Zealand is to take control of its own future, then there has to be a regulatory mechanism such that the majority of Treasury bonds must be held by New Zealand entities. That is entirely feasible, and it would be one step towards bringing our foreign exchange rates under the influence of trade flows rather than dominated by the whims of overseas financial derivative traders.

Given all of the above, I think I can see another article forthcoming that looks at the role of international capital in dominating our economy, including whether New Zealand needs to direct more of its own savings to productive investments. The logic of allowing foreign entities to buy-out our elderly-care facilities might be a good place to start.  How does that build New Zealand? That has to wait for another article.

*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. He can be contacted at

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No. They only stimulate housing and stock markets. We have experienced this for the last couple of years and America has experienced this for a longer time.


Agreed and it also causes high risk to our banking system and punishes those who are trying to save for the future. Only a year ago it would have been unthinkable that mortgage rates could drop below 3% now we're plummeting towards 1% and possibly lower to create more life long debt.

The real issue these banksters are trying to defer is deflation, which is not exactly great for business if you are lending money.

These banksters have lived on the pretext there will always be overall growth. With the earths limited resources, there comes a time when the natural ecosystem can no longer support continued growth. Nature has come calling, and while some places continue to grow more are in decline. We have been in the space where we are robbing Peter to pay Paul, and have been for longer than you think. This is no more apparent than the US, were the parasites are now eating their host.

You might ask who these parasites are. Well they are the global banking elite and the public company executives, who take way more than their fair share out of the finite system. With mass company aggregation and share buybacks, they have started to eat themselves and we all know this doesnt end well.

Low interest rate can help but can it be the sole saviour in current situation - No.

Low interest along with QE can help to reduce or delay the consequence of Corona virus and it's lockdown world over but doubtful that will save the economy from consequences, if can than their will never be any meltdown and no more economy cycle of up and down, will always be up up and UP.

Well, high interest rates don’t seem to suppress irrational high property prices.
The damage done to the productive economy from the late 80s to 2008 which included very high interest rates - we are still feeling the after effects.
Other tools to dampen property prices need looking at, not simply interest rates.


the mid 80 had high interest rates, from then on they have been falling. If interest rates now were 10%, property prices would not be anywhere near what they are now. A typical Auckland FHB mortgage would cost $1400/week. That simply wouldn't work.

NZ has structural relatively high interest rates since 1980s as a deliberate policy.
Bollard was raising interest rates right up to the GFC - 10/11% mortgage rates as a result - and yet house prices were still rocketing up.
So the relationship between raising interest rates and lowering house prices is not quite as straightforward as you suggest.

Fixed rates did not exceed 10%.

And the relationship I suggest is that its quite simply impossible for a typical NZ income to support current house prices at a 10% interest rate.

Ok, floating hiked up to 10/11% in 2008, fixed hiked up to 9%, with little immediate effect in rising house prices. The dampening effect of higher interest rates on house prices going forward is not as directly causal as many expect.
Just as currently reducing mortgage rates currently are not necessarily the main boosters to the housing market. Add to the mix, rising wages (wages up 3% public sector, 2% private sector last 12 months), confidence, belief in the durability of property, flight from TDs, a FOMO by FHBs, available disposable funds from cancelled OE holidays, etc.
interest rates are now less critical - people now believe cash is cheap & not particularly valuable.

"Just as currently reducing mortgage rates currently are not necessarily the main boosters to the housing market."

"people now believe cash is cheap"

well, duh!

Mortgage belt
High interest rates plus high inflation will still cause property prices to rise, driven by those who can manage the cash flow costs of the interest, and constrained by those who cannot. In general, it leads to the rich getting richer.

Right now, there can be little doubt that quantitative easing is contributing to declining interest rates.

Are you sure? - the 10 year NZ Government note low yield prior to QE on 9 March 2020 was 85 bps, today 83 bps.

The policy is very effective in that regard because it is helping to create a flood of capital looking for a home. It is all about supply and demand.

The Crown issued $24.405 billion net new government debt in the three months ending June 2020. The RBNZ conducted $18.347 billion settled LSAP purchases, including NZGB and LGFA securities over the same period.

It would seem a large percentage of this so called flood of money sits on the RBNZ's liability ledgers in the form of inert government and bank asset claims.

Bank Reserves Part 1; The Great Tease
Bank Reserves Part 2; If QE Was Really QT, Then Why Hasn’t QT Been QE?
Bank Reserves Part 3; In Practice

Cash on the sidelines and zero prospective returns

As I observed early in the global financial crisis, you’re going to see a lot of chatter about “cash on the sidelines” in the months and years ahead. That’s because the Federal Reserve is creating a mountain of the stuff. The moment the Federal Reserve creates base money (currency and bank reserves) to purchase some asset, the base money it creates must be held by someone in the economy, at every moment in time, until it’s retired. A dollar of base money is just another type of “security.” A given holder of cash can try to get rid of it by buying other pieces of paper like stock shares or bond certificates, but the seller of the stocks or bonds immediately becomes the new holder of the cash.

So “cash on the sidelines” can certainly change ownership, but it can’t go “into” the stock market, or the bond market, or anywhere else, without coming right back out in someone else’s hands. Once a security is issued, that security has to be held by someone, at every moment in time, exactly in the form it was issued in, until that security is retired. That holds for base money as well.

Also remember that the moment the government runs a deficit, somebody has to run a “surplus” of income over and above consumption and net investment. That “surplus,” in equilibrium, is held in the form of whatever liabilities the government issued to do the spending. If the government finances the deficit by issuing Treasury bonds, someone is going end up holding more Treasury bonds. If the Fed buys the Treasury bonds and replaces them with base money, someone is going to end up holding more base money.

If investors are inclined to speculate, the pile of zero-interest hot potatoes created by the Fed can certainly encourage them to chase other assets, which is how the Fed has created an “everything bubble” in recent years. The problem is that as valuations rise, future return prospects fall, and we’ve now got the worst investment menu for passive investors in the history of the U.S. financial markets. Everything is priced for near-zero returns. Link


Today's ever lowering interest rates are there to prevent debtor defaults and maintain support for the debt fueled ponzi of the last decade.

We're pretty close to zero bound and rapidly running out of road. Just to add to the mix rising international tensions, autocrats in power in China, Russia & USA, a global pandemic and global recession looming

The debt edifice currently maintains a semblance of stability but I fear a major meltdown is coming.

It could have been prevented years ago by less short term thinking but now it's too late. There will have to be huge destruction before we can rebuild again on a more solid base.

This is nothing new in the cycle of things but greed for wealth and power always seems to win the argument - until, that is, it painfully doesn't.

Tom Joad. I think you're correct. There has to be an adjustment before rebuilding (Schumpter's creative destruction is still important IMO). The general public are led to believe that things 'return to normal' organically in terms of how the economy works. I think what is misunderstood is that h'hold incomes are relatively fixed. Debt bubbles enable h'hold incomes to grow, but the misguided belief is that this just continues forever and a day based on the central banks / govts issuing more paper and stimulus.

We have Japan as the perfect illustration as to why print and hope doesn't preserve the status quo. It took the Japanese quite some time to understand that and they're still struggling with change even today. But they have been forntuate in that there is a semblance of sanity in their economic profile: they generally don't spend beyond their means at the h'hold level and in private firms. They have huge industrial ouput and relative productivity. Compare that to say NZ and Australia where it's all about hope and spend into the consumer economy where hopefully that will translate into higher income growth. This is what our bubble economics is all about.

JC and Tom Joad,
Yes, I sometimes wonder what Schumpeter would say if he were with us today. I think he would still argue for the importance of creative destruction, but with the more crowded world it is not easy to find the way ahead.

Yes, I sometimes wonder what Schumpeter would say if he were with us today. I think he would still argue for the importance of creative destruction, but with the more crowded world it is not easy to find the way ahead

Keith, I would say we're already seeing example of creative destruction. Going back to my case of Japan, Uniqlo was one of the first to change the way fast fashion operates and is now arguably the world leader in that space. Furthermore, Daiso and TopValu brands changed the supply chain model so that you only needed to spend $1 on a low-involvement product such as an eggslice or dishwashing liquid.

He might say that just because the bank I was a director of went broke, leaving me with a large debt, that doesn't mean I know nothing but theoretical stuff about economics and commerce. He might also say that just because I was born in a Town now part of the Czech Republic then part of Austria-Hungary, I can still call myself German. He might have also said that my saying that capitalism means continual evolution and creative destruction hit the nail right on the head.

Debt that cannot be paid off must be written off. There is a reluctance by lenders to acknowledge this, because doing so would in most cases bankrupt both borrowers and lenders. Instead they play " extend and pretend" with the connivance of the Reserve Bank.

Can low interest rates really stimulate the economy?

The data suggests overall that statistical causality runs from economic growth to long-term interest rates. Nominal GDP growth provides information on future interest rates better than interest rates inform us about future nominal GDP growth.

Our empirical findings reject the canonical view that interest rates somehow affect economic growth, and in an inverse manner. To the contrary, long-term and short-term interest rates follow the trend of nominal GDP, in the same direction, in all countries examined. This suggests that markets are not in equilibrium and the third factor driving GDP growth is a quantity – as shown by Werner, 1997, Werner, 2012a in the case of Japan (namely, the quantity of bank credit creation for the real economy - i.e., for GDP transactions, as the Quantity Theory of Credit postulates; Werner, 2013a). Link

Hi Audaxes. I’ve seen you post before that low interest rates imply a weak economy. But also, a weak economy does not seem to mean reduced asset prices, on the contrary, a lot of what middle NZ is exposed to has been going up since April. Is the only deleterious outcome here that residential mortgage rates do go up, harming those who are locking in debt now? When the economy heats up we might perversely have to restrain productive investment in favour of higher repayments on e.g. residential mortgage debt?

Yes, I am comfortable as to that direction of causality. It is why interest rate polices are a blunt tool. And that bluntness has increasingly led Central Banks into QE. But QE can be a rocky path.

"... . Once COVID is eventually overcome, then the inflationary forces will truly be unleashed as banks once again use their augmented reserves to create credit which multiplies its ways through the system."
The question is: When is this going to happen? In the last couple of weeks, the bond market was became even more pessimistic on this happening any time soon. Two week ago the the 10 year yield was 1% now its 0.83%, this is not confidence that we will be seeing inflation anytime soon.
I agree with you QE is not stimulus but it does keep things from falling apart which is the main goal. What happens to already shrinking dairy lending if lending rates go up? Without the end of lock-down mortgage rate cuts would there have been as many buyers? Of course stopping the bankruptcies creates zombie businesses that completely kill off the recovery but more QE is always the most painless short term option.

We are in agreement that 'QE is always the most painless short term option' . And there lies part of the problem.


When the rules of the game change in the middle of the game

QE as practiced in USA by Bernanke was intended as a temporary measure lasting 6 months to put a panic-safety-net under the high-flying trapeze-artistes. A USD $4 trillion safety net. It worked in the sense it saved the big end of town. It saved the big merchant-banks who held the rotten-paper they had themselves created. QE replaced the rotten-paper CFD's etc. Trouble is they haven't withdrawn that 2008 QE. It's still sitting there. There was a slight attempt to withdraw some of it in 2019 with some gnashing of the teeth. The GFC was a financial crisis. This time it is a crisis with a different cause. The response has been to throw more QE at it. Now its up to USD $7 trillion in the US, $15 trillion world wide. And they can't repay it. It won't be repaid this year. Or next year, or the year after. The global economy is held up behind the 15-gorges-dam awaiting a solution. Repay it and ruin the global economy. Or inflate it away - some day in the future. they can't repay it. And there is more to come. They know-not what they do

The real question is - what happens to it
If you have the capacity to pay the outgoings, buy property, otherwise buy gold

If you have the capacity to pay the outgoings, buy property, otherwise buy gold

I like that. Gold is now the poor man's property. That would mean silver is something for the really really poor.

And if gold is the poor man's property, that might go some way to explaining why the millennials are pouring into onwership through tools like RobinHood.

There’s the upside for silver right there...not many on main street could afford an ounce of gold @$2000 but plenty will buy silver at $30, 40, 100 an ounce.

But you don't need to spend $2000 to buy a piece of gold. A share in GLD is approx USD170.

Still heck of a lot cheaper than trying to play property.


I prefer to hold my metals thanks.

short answer is "No" QE cant stimulate our Tourism, Intl Student, and migration sectors.

It can replace the money lost by Fiscal spending, but how long will we have to lock our borders waiting for a vaccine, if its 3 years then we are best to ration our QE rather than trying to keep everything propped up and eventually crashing

Why is inflation even mentioned when we are in the grip of a deflationary cycle that started slowly about 2 years ago

whats your evidence for this statement?

We are close to short term deflation driven by tradables. The inflation will be later.

If we think of the combined entities of the Treasury and the Reserve Bank, which we will call ‘the State’ then the payments of interest on the Treasury bonds by the Treasury to the Reserve Bank are internal transfers. Overall, it costs the State nothing.

The government's interest rate risk has swapped from fixed to floating since the RBNZ pays out OCR to the banks which exchanged bonds for central bank reserves in the LSAP (QE) transaction. Furthermore, when the RBNZ held bonds mature the redemption proceeds pass from the government via the RBNZ to the banks to extinguish/liquidate the reserve liability.

This amounts to more than nothing.

Once the RBNZ has purchased the Treasury bonds then the commercial banks are out of the equation. All subsequent actions - be that interest, capital payments or write-offs are transfers between elements of 'The State'.
The exception is if the RBNZ decides to do some quantitative tightening and sells these back into the market. I won'tt be holding my breath for that to happen.

A comment from Michael Reddell - ex RBNZ economist.

One of the incidential curiosities of the bond purchase programme is that at times like this you hear a great deal of talk about how it is a wonderful time to borrow and the government can lock in very cheap long-term funding. And yet what do really large scale central bank bond purchase programmes do? They transform the liabilities of the Crown from quite long-dated to increasingly quite short-dated, exposing the Crown (us as taxpayers) to really substantial interest rate risk. Perhaps at the end of all this the Reserve Bank will have $50 billion of government bonds, with a representative range of maturities. On the other side of its balance sheet, it will have a lot of very short-dated (repricing) liabilities – all that settlement cash (see above). Whether the Bank eventually sells the bonds back into the market – which hasn’t happened a lot in other countries – or holds them to maturity, the interest rate risk doesn’t go away. It isn’t obvious what public interest is being served by skewing the Crown’s (net) debt so short term. Perhaps interest rates will never rise again……but that won’t be the view many people will be taking, Link

From the RBNZ.

From 20 March 2020:

Allocated credit tiers for ESAS account holders will be removed, and all ESAS credit balances will be remunerated at the OCR.Link

Things have moved on somewhat since Michael Reddell wrote that particular article. QE has expanded and term deposit rates have dropped. What is your particular point?

I made it above.
"The government's interest rate risk has swapped from fixed to floating since the RBNZ pays out OCR to the banks which exchanged bonds for central bank reserves in the LSAP (QE) transaction. Furthermore, when the RBNZ held bonds mature the redemption proceeds pass from the government via the RBNZ to the banks to extinguish/liquidate the reserve liability."

A recent Bloomberg article described central bank easing with the phrase “pumping money into the economy.” That’s a misconception. Monetary easing is actually an asset swap. The public was holding savings in one form, and now it holds it in another. The Fed buys Treasury securities from the public, and replaces them with currency and bank reserves (base money) that someone has to hold, at every point in time, until the Fed sells its bonds and retires the cash. All monetary policy does is to change the mix of government obligations held by the public. Only fiscal policy – specifically deficit spending – changes the total amount of those obligations.

If someone is holding their savings using one asset, and then holds it using a different asset, it doesn’t prompt them to suddenly run to the Best Buy to blow it all on electronics and appliances. QE can certainly encourage financial speculation and “carry trades,” where interest expense is the main cost of doing business, but there’s no reason for that asset swap to produce either real economic activity or inflation.

Historically, base money has earned zero interest. Forcing people to hold more zero-interest money makes them more eager to chase interest-bearing alternatives. That response made for a very pretty relationship between the ratio of base money / nominal GDP and the level of Treasury bill rates at any point in time. In recent years, the Fed created such a huge pile of zero-interest money that the only way it could raise interest rates, without slashing the size of that pile, was to explicitly pay interest on excess reserves (IOER).

Without IOER, short-term interest rates would only be about 12 basis points here because the Fed’s balance sheet (of Treasury bonds purchased from the public), and the corresponding pile of base money (held by the public instead) is still ridiculously large. If the Fed lowers interest rates today, it won’t be by “pumping money into the economy.” It will simply be by lowering the interest rate it pays on excess reserves. It may even create more reserves by buying more Treasury securities (QE), but again, even that is an asset swap.Link

The flaw in this is to think of the asset swap in isolation from the system. As a starting point, what happens with the reserves held by the banks at the RBNZ is under the control of the banks, not the RBNZ, as long as the banks stay within their regulatory requirements. In all likelihood, the Treasury bonds held by the RBNZ will at the time of redemption simply be replaced by new bonds. The only effect on the banks is via an intermediation fee for the new bonds- assuming the RBNZ continues to only operate on the secondary market.

Redemption Day
Keith: "Treasury bonds held by the RBNZ will at the time of redemption simply be replaced by new bonds"

Thanks: You saved me the trouble of saying that. Come the day of maturity, those Bonds will be rolled over. The debt will be perpetuated. I cannot see it being repaid. There will be no "Redemption"

They will be redeemed under the terms of NZ Government bond contracts - promises to pay. That does not preclude the issuance of new government debt prior to a bond expiry that can be swapped for reserves by the RBNZ under the auspices of the LSAP programme. This happens all the time. The government has recently issued two new syndicated bonds, 24s and 41s (~$11.0 billion) in preparation for the $11.309 billion 6.0% 15/05/21 redemption.

Technical - you are talking about the bonds - I'm talking about the underlying debt - but still rollovers - in the cash settled derivative markets, rollovers from the front month to the back month, in the week before expiry/settlement, are done all the time

The point is the RBNZ does not purchase these bonds, thus there is no money in QE and no inflationary impact - it exchanged central bank reserves for them - hence the swapped bonds on the asset side of the RBNZ's ledger must be matched by the RBNZ reserve liabilities which are OCR interest earning bank claims (securities). These claims must be collectively held by the banks until the RBNZ sells the bonds or they are redeemed.

The action of government rolling over existing bonds held by the public and the RBNZ or deficit spending more into creation is an entirely different matter linked to fiscal policy.

But the RBNZ does purchase the bonds!
It is important to think not only in terms of the ledgers, but in terms of the flow of available funds.
Looking only at the ledgers obscures the creation of money.
When Treasury creates bonds which end up with the RBNZ, then the net effect is that the Treasury has acquired the finance that it needs. The banks are in exactly the same position they started with - they used their reserves to buy the bonds from treasury and these reserves have been replaced when they sold the bonds to the RBNZ. The finance that the Treasury now has is additional money circulating in the economy rather than having acquired existing money that was taken from the market. It is called QE for a reason.
It is not correct to say that the banks have to hold their reserves until the RBNZ sells the bonds. The reserves are not tagged in any way to the Treasury bonds that the RBNZ now holds.

As Hussman points out central banks engage the banks in an asset swap when conducting QE, not an outright purchase.

Reserves do not come into the equation in respect of the government raising funds for deficit spending. Private sector savings are the source of these funds, admittedly created out of thin air by banks.

I suggest further reading about the role and restrictions of reserves,

Furthermore, I understand the Dec 2019 bank reserves stated in terms of bank settlement accounts were raised in the first instance via an FX swap between the RBNZ and banks. The RBNZ gained foreign currency reserves and the NZ banks RBNZ $NZ reserves.

When the RBNZ purchases treasury bonds it is an outright purchase, not a derivative swap.
In relation to the trading bank it can be termed as a 'swap' of assets but this is not done through a derivative. The bond is now owned by the RBNZ with the Treasury now the only other counter party.
When the trading bank issues a loan to a client then the transfer is managed through the ESA system and the reserves held at the RBNZ are adjusted accordingly.
It is true that the trading bank does not 'lend out' the reserves in the way that shares can be 'lent' for the purposes of shorting. But it is the reserves that give the bank the capability to lend.

Believe what you like but reserves are not a necessity for banks to lend in NZ . Point to an RBNZ ledger where the publicly defined fractional reserve ratio and the retained reserves are recorded.for the purposes of lending.

New Zealanders and borrowers may think their interest rates are low atm, but they are actually still much higher than most developed countries. The UK and Germany offer 1 or 2% mortgage rates, and have been much lower over decades compared to NZ.
NZ has only just recently been permitted mortgage rates of 2.5% which others have enjoyed for years.
Our economy is stifled by high mortgage rates, high house prices, with 40 to 70% of some households disposable income going to mortgage repayments or rent.


You’re assuming that these lower rates in other countries have helped stimulate their productive economy which all evidence suggests the opposite. As the article states, the lower rates go the more people save, that is the velocity of money decreases. What all these economic models fail to account for is human behavior. All lower rates have done is allow people to “afford” larger and larger mortgages, thus allowing for the property Ponzi scheme to continue.

You’re assuming that these lower rates in other countries have helped stimulate their productive economy which all evidence suggests the opposite. As the article states, the lower rates go the more people save, that is the velocity of money decreases. What all these economic models fail to account for is human behavior. All lower rates have done is allow people to “afford” larger and larger mortgages, thus allowing for the property Ponzi scheme to continue.

Fantastic comment. Behavioral economics is a discipline where the central bankers and economists are practically amateurs (OK, not the likes of Shiller).

Try borrowing at these alleged low rates. I tried for a small property development with a freehold property as security. 75% equity. My Aussie bank said 12-14% interest because of the risk. I closed those bank accounts and carried on with my new Kiwi owned bank.


The frightening dilemma that QE faces is not financial gymnastics, but social upheaval.

If the aim of QE, in any of its guises, was to 'inflate the debt away'( in effect, higher wages to do so, at the same time as that impossible trick of keeping the debt static) then that possibility has evaporated with unemployment. Once your Government wages support mechanism is finished (for however long that is in any particular location) that $100k job you had, that was abolished, won't be replaced by another one, either by you or your recent employer. Neither will you find a similar replacement job at the same rate of pay, as others will outbid you with their new, lower-wage demand.
It's all looking a little more alarming than even the most prepared of us might have imagined.

Financial catalysts tend to result in sudden, cataclysmic collapses in liquidity, solvency and sentiment. While the Federal Reserve can "fix" liquidity crises by "creating currency out of thin air", that doesn't make bankrupt firms solvent or make employers hire employees. Once complacent confidence slides into cautious fear, massive liquidity injections to keep the system from crashing are seen for what they are; last-ditch desperation.

(CH Smith)

It just keeps the debt in the system from face planting, aka propping up the asset bubble as assets prices move further from reality. Debt at it's current levels is a form of enslavement for those at the wrong end of it. Some winners, but lots and lots of losers.

Indicators show the USD is getting wobbles. Whether it craps itself or not remains to be seen, but they are mismanaging their position as the reserve and warning signs are left and right.

If interest rates at zero, time isn't relevant anymore. To break that circle that's going to hurt. Now it's hurting the ones who thought they did right thing. So hardworking is next thing we destroying.

To me - in my simple minded thinking - that it seems that QE and reducing interest rates by central banks were to minimise the consequences of the fallout of the GFC. The intent seemed to be about economic stability - primarily about keeping businesses operating and people employed. However, the consequence of that was falling interest rates, and increasing asset prices especially the equities and housing markets.
It seems that in this action there has been winners as unemployment has been kept at traditionally low levels, the economy has been buoyant, homeowners have seen their house value increase, and there seems to have been a minimal number of bankruptcies. However, there has also been a number of losers such as FHB and those - such as retirees - who are cash rich and seen diminishing returns. We seem to overlook - or turn a blind eye - to the positive effects in response to the GFC (saving the business and employment) but, as we are negatively affected by them, we focus and tend to be very vocal on the downsides of FHB high house prices and retirees low interest rates.
I am reasonably relaxed about this as in most economic situations there is always going to be the winners and losers. In my past experiences is that over time the economic situation changes and so do the winners and losers. However, this does not seem to be currently happening and in response to Covid it is same old, same old ongoing action.
It is of concerns that we have now had a decade of central banks involved in this consistent one-way repsonse of QE and reducing cash rates. Clearly this is not sustainable; we now talk about astronomical levels of debt (USA heading to 130% of GDP) and talk of negative interest rates here in New Zealand.
Clearly as a tools for economic stability QE and cash rates have a limit and they now seem increasingly appearing to be unsustainable. Covid just seems to have hastened the crunch point along.
To me, I fear that the next decade is one of high uncertainty and fragility.


As a saver I became more and more angry with the RBNZ as it lowered interest rates and house prices escalated. But on reflection I do not believe the RBNZ are the real villains.
Since globalisation there would appear to be an endless supply of goods at competitive prices. Wages have not risen noticeably for decades. So little inflationary pressure. But huge rises in capital asset prices. Their mandate to keep the CPI between 1-3% is not achievable when that measure does not seemingly reflect the rising house prices.
So I believe the villains are the politicians who have established a poor mandate, allowed unfettered immigration, allowed foreign ownership and hamstrung development through the RMA and ever increasing regulatory cost.
I am hoping at this election to find a party that would address these issues. Not holding my breath.

What I can't understand is that house prices go up 50K and rents go up at 3K a year, that's is already inflation of 3% over a 100k family income. Numbers are so twisted.


Sadly we haven't had a politician with vision and balls for a long time, just short term populists (JC, JK included). We badly need someone who can sell the nation a big bottle of short term pain for long term gain.

People might .. MIGHT say, "not getting any interest in the bank, MIGHT as well just spend it ALL." Obviously the idea ..

Ruins capitalism though, because people fail to save enough CAPITAL to start meaningful businesses. Terrible for jobs-of-the-future. Cashed up older people are the future, not the children?

But again, there are real alternatives to the NZD. When your money produces no return and fails to hold it's value .. only option is to demand more tax to artificially stimulate demand for your currency.

At this point the jig is basically up.

Agreed with most of this except premise that loans are funded by deposits. Plainly they are not. Loans via double standard are renamed assets which banks leverage via free air. Investment in productive business is a miserly % of banking lending. Housing is not productive of anything but gains for top half of pop

Agreed with most of this except premise that loans are funded by deposits. Plainly they are not.
Indeed. IMF has this to say:

Three structural features of monetary systems form the starting point for this paper.

They include (1) a two-layer structure comprising a private sector agent deposit system with commercial banks, parallel to a commercial bank deposit (reserve) system with central banks, with the two being separate and not allowing transfers between the two, that is, reserves cannot be “lent out” to the private sector (Sheard 2013); (2) the fact that money is created upon the creation of bank loans (Werner 2014/16), while repayment implies money destruction, both of which are an accounting reality, and implying that banks would better not be called “intermediaries”; and (3) the fact that the money stock is endogenously and elastically driven
by demand and constrained loosely by regulation. The constraints to the provision of new credit include capital regulation, banks’ conditionality on an incremental profit prospect, and, eventually, demand (McLeay et al. 2014)1. Link


Fed Chair in House Hearing on Financial Services: "The private sector is not involved in creating the money supply"

Mr Powell, can you please read these papers? Link


But from the point of view of the bank, it has acquired the security without giving up any cash; the counterpart, in its balance-sheet, is an increase in its liabilities. There is expansion, from its point of view, on each side of its balance-sheet. But from the point of view of the rest of the economy, the bank has ‘created’ money. This is not to be denied. Hicks (1989, 58)

We start with the idea of credit creation, specifically a swap of IOUs between a bank and myself involving a bank loan that is my IOU and a bank deposit that is the bank’s IOU. Nothing could be simpler, and yet the mind rebels, especially the well-trained economist’s mind, because this simple operation increases my purchasing power without decreasing anyone else’s. It seems like alchemy, or anyway a violation of some deep conservation law. Real productive resources are the same as they were before, and the swap doesn’t change that, does it?

Spending of the new purchasing power adds another layer of perplexity. If spending increases but real resources do not, then it seems logical that the increased spending must exhaust itself in higher prices—that is the intuitive appeal of the quantity theory of money. My purchasing power may increase, but everyone else’s decreases because their money balances buy less. From this point of view, the alchemy of banking seems like a kind of theft, something to be deplored in the name of economic science and if possible outlawed in the name of the general good. Link

You first link is to an IMF working paper. As such it is a working discussion paper by some staff and does not represent an official IMF perspective.

"There were two major evolutions in money and banking that seem to fall outside the orthodox narrative. The first was a shift of reserves and bank limitations from the liability side to the asset side. The second was the rise of interbank markets, ledger money, as a source of funding rather than required reserve balancing: replacing the old deposit/loan multiplier model". Courtesy of J. Snider from Alhambra


As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions. Link

Not that it mattered. The Fed provided loop holes as far back as 1994.

In this analysis, we interpret the effects of deposit-sweeping software on bank balance sheets to be economically equivalent to a reduction in statutory reserve-requirement ratios. We seek to measure the amount by which such deposit sweeping activity has reduced bank reserves (vault cash and deposits at Federal Reserve Banks). Currently, transaction deposits are subject to a 10 percent statutory reserve-requirement ratio on amounts over the low-reserve tranche ($44.3 million during 2000, $42.8 million during 2001), whereas personal-saving accounts, including MMDAs, are subject to a zero ratio.3


I always pay attention to Keith's articles and this is no exception. However, I don't understand why the Phillip's Curve warrants a mention.
I see no point in using a so called economic law that only works occasionally. There several periods when it-the Phillip's Curve has quite clearly failed; periods such as 1960-65 with both low unemployment and low inflation; '65-'68 with low unemployment and high inflation and '77-'81 with both high unemployment and high inflation. (This relates to the US).

Then it's not very relevant is it? Doesn't really matter which dress you put on the pig.. it's still a pig

The Phillips curve is relevant because it underpinned so much of the subsequent monetary theory, rightly or wrongly. Ironically, Phillips did not consider it his most important work, but it is what he is remembered for. Also, it acted as a pivot point from the Keynesian focus on fiscal policy towards much greater focus on monetary policy than had previously ben the case. And it led through into the NAIRU ideas of non-accelerating inflation, and I believe that these ideas are still in vogue within the RBNZ

I think overall low interest rates support economic activity more than detract from it.
As a generalization it is older people who are more reliant on term deposits. In general, older people tend to spend less than younger people.
Note - I am talking about economic benefits in the consumption part of the economy. I doubt very much that low interest rates are doing much to bolster investment.

QE is not driving down interest rates, it is just making money switch places and such money is not going into everyday's shopping or families unfortunately. Interest rates go down for two reasons 1) the RBNZ has set the OCR to the lowest it's been which gives more room to banks for profit and 2) since less and less are able to afford their own home, banks should compete for those that still can and the only way to make this group larger is to compensate making rates lower and mortgage periods longer.

The inflow of foreign capital is the key variable that Keith has not focussed on. The problem is that, contrary to the groupthink and bank propaganda of our times, foreign capital inflows into an advanced economy usually result in either increased debt or increased unemployment.

Michael Pettis covers this in great detail. The essence of the argument is that, because of the mathematics of double entry bookeeping, each dollar coming in from overseas as capital must reduce export sales of goods and services by a dollar, unless it is balanced by a dollar of NZ capital going overseas.

As BIS pointed out the other day, Australian banks are significant lenders of USD in the FX Swap market. This usually involves our local banks borrowing Kiwi from a supranational counterparty which has issued NZ monetised Kauri bonds. Hence there is no inward flow of foreign currency into NZ borders. The foreign Supranational borrows the USD out of London in the XCCY basis swap which our local banks lend from their London branches - they will have a foreign loan liability on their offshore, off balance sheet books.

Isn't that something of a distraction? I was interested in the effect of foreign capital inflows on reducing export profitability and export income.

No one imports foreign currency into this country, except small amounts of paper notes and coin. At best NZ based foreign currency borrowers sell it on the open FX markets for domestic NZD currency - but then there is an unhedged currency risk position.. What I described is hedged position taking. But it is all really a waste of time when our local banks can create the necessary domestic funds on the own balance sheets. We continue to pay tribute to foreign lenders seeking colonial era banking fees.

Yes, indeed, no quarrel there. I think we have adopted a bank friendly thought framework around capital flows. Result, they enjoy enhanced privilege and we pursue policies that are more in their interests than ours. We should focus on capital generation via increased profitability of kiwi owned businesses. We should be running a current account surplus, based on profitable goods and services production, not selling houses to new residents and borrowing more from overseas lenders so we can bid against each other for a better barn to live in.

I agree that foreign capital flows are important. I touched on that when I referred to the importance of regulations to ensure the majority of Treasury bonds are held by NZ entities. But there is a lot more that needs to be said. For a long time, the NZ foreign exchange market has been a plaything for international derivative traders driven by their own self-interests. In the world as it now is, there is a need to ask whether those interests align with the interests of most New Zealanders.

I think the concern about short term traders is largely misplaced, probably misdirection from the special interests that benefit from the present set up. My concern is that for decades we have followed the advice of the big four overseas banks who have a much better grasp of how finance works. This is understandable, since they have learned from the Wall Street banks how to set up a system which works to their benefit.

The trick is in the framing of the debate. It is not free capital flows good, all capital controls bad. The settings need to vary with the circumstances. Personally I think the RBNZ should be tasked with putting forward proposals to balance the current account or run it "at a mild positive over the medium term". I suspect inflation targetting has had its day, it worked to reduce inflation and encourage us to take on more and more and more debt, just as the banks new it would all along. This has provided a never ending flow of payments to the banks but has weakened our real equity wealth.

On a separate but related matter, as a businessman, I am not very concerned with the interest rate, or with inflation, when making an investment. I am extremely concerned with the expected volatility of the interest rate. Business investment (as opposed to speculation in financial assets) requires the expectation of stable or declining volatility, whether that be in interest rates, FX rates or regulations. This is why business investment is usually less when a Labour government is in power, as they are more likely to make sudden and large changes.

The RBNZ groupthink about inflation is misplaced as is the groupthink about Labour being for the worker.

The RBNZ only controls monetary policy. In practical terms it is beyond their capability to eliminate the current account deficit.
The current account deficit arises from a long history of foreign investment in NZ.
Eliminating the current account deficit could only be achieved by running a much greater trade surplus and this could only be achieved with a much lower exchange rate that discouraged imports.

Exactly, the business model would have to change, from one skewed towards selling shares in NZ Ltd to foreigners and spending the proceeds on consumption items, to actually earning a living. We are burning capital, living off the great estate we have inherited, by selling it off bit by bit. Typical third generation stuff.

The first generation works hard and creates a business. The second generation learn from the first and grows the business. The third generation see wealth as their entitlement and piss it all away.

My contention is that the exchange rate is structurally too high, not necessarily by much, and this is due to our misconception about the usefulness of foreign capital. Foreign capital flows into the NZD to buy government bonds, mortgage loans and property assets, depressing exports as a chained result. It is essential to understand this is not a cause and effect relationship in the usual way, but a chained effect due to double entry maths. The subtle mathematics of double entry is beyond most people as it not taught much in school due to the medieval snobbishness towards matters of money and business that permeates education to this day. I studied Physics at university and had never heard of it until I went into business, its subtlety still astonishs me.

Just substitute NZ for UK in this article:

Government bonds can only be purchased with NZ Dollars which can only have been be created by the government in the first place. The government does not borrow in foreign currencies, it is a sovereign currency issuer. Foreigners will always end up holding NZ Dollars through normal trade with us.

Surely they must buy the NZD off someone else in order to buy the bonds off the govt? Those NZD are usually created ex nihilo by the private banking system. Sort of 0 = +NZD1 - NZD1, et voila. Thus foreign currency (capital) buys NZD which the government spends on consumption items. We are living off the accumulated capital of the country.

Yes, these bonds are indeed denominated in NZ dollars but they are purchased, via the foreign exchange market, with (typically) USD. On the other side of that exchange is someone selling NZD for USD. That can either be an importer needing USD or, less commonly, the RBNZ intervening in that market. Either way, the inflow of USD into the market (or outflow when foreigners sell their bonds) affects the exchange rate through normal supply and demand pricing.

Hi Kieth,
Interesting article.
I think your first 2 sentences sums up the intention of the RBNZ with both QE and the OCR. .. to lower interest rates across the curve.
Of course no Central bank can control "animal spirits" so in regards to correlations, one needs to use common sense . ( I never accepted the idea of the philips curve )
I dont think its inflation , per se, but Money supply ( credit growth) that is the determining factor.
(In Friedmans day inflation and credit growth were kinda seen as being almost the same thing.)
The nature of our fiat monetary system is that we need continual credit growth, in order to generate GDP growth. ( I like Ray Dalios economic model which is transactions based. He says spending drives the economy and spending comprises of money + credit.. In this context we can see how credit influences economic activity and employment)

In regards to low to -ve real returns on savings resulting in NZers saving more... I'm not so sure. Nzers' might have a "different" psychology to other countries. I think when we enter a more risk-on environment Kiwis will rotate more of their savings to hard assets like property. I also think retired people will simply start consuming their Capital. I'm sure Banks will be keen lenders again.... soon enuf.
If this happens, we will start to look like Japan did in the mid to late 80s' .. especially If commodities start booming again .. A crack up boom before inflationary pressures kick in that brings on rising interest rates and the deflationary crash, and/or the proverbial lost decade of zombie economy....

In regards to the next article u are planning to write, keep in mind that NZ is a chronic Debtor nation that has never ending Current Acct deficits. If NZ wanted to take control of its own future , this might be something to look at. Im not sure NZ is in a position to have controlled financial Borders..?? We are totally reliant on Global financial flows..

Here is a link to a site that uses older methods of calculating inflation back in the 1980s and 1990s. Using a 1980s' based measure US inflation is running around 8-10 %. I think it is interesting, but have no idea if its true or not. Also check out the chart of Money supply growth

I think Friedman's perspective was that the money supply needed to increase in line with GDP, and that perspective seems to have merit, but I see no evidence in the world we now live in (even pre-COVID) that it generates or drives increased GDP.

I think it does.
GDP is measured in $dollars. If money supply does not increase then productivity gains would manifest as a benign deflation. ie. cheaper prices.
With a fixed quantity of money supply we would have a relatively constant GDP, but the purchasing power of money would increase.
What I'm alluding to is that alot of nominal GDP growth is illusionary and is a function of credit growth. Economics makes the distinction between real and nominal gdp. In the everyday world it's actually the nominal gdp that is reality.
Am I missing something here ?

I think GDP increases as commonly referred to are real (inflation adjusted). So when economists are saying that inflation stimulates GDP they mean real GDP.
We should also be looking at real GDP per capita, but our Governments tend to shy away from that as it makes things look worse.

I focus on Monetary inflation rather than CPI inflation. ( you also allude to the difference between tradables and non tradables )
In 1988 M3 money was about $68 billion and nominal GDP was $65 billion.
In 2017 M3 was about $495 billion and Nominal GDP was $270 billion.

new money can only enter an economy in 3 areas.. 1/ Investment, 2/ speculation, and 3/ consumer spending. ( as far as I know ).
A Canadian Central Banker famously said ..." We didn't abandon the credit aggregates, they abandoned us". ( ie. relationship between money supply and cpi inflation seemed to be no longer that relevant )
What he missed was that Monetary inflation ( new money ) can manifest in different ways, in an economy, and not just thru CPI inflation.
Post GFC credit aggregates are being watched more closely.

As far as I know ( I'm not an economist ) nominal GDP growth can only come from a mix of productivity gains, population gains and an increase in Money supply. (Using a GPD deflater kinda muddies the waters for me. I look at the rate of money supply growth)
Over 30 yrs money supply has increased at a rate of around 6.5% compounded.
Over 30 yrs nominal gdp has compounded at a rate of about 5%

Nominal GDP is more meaningful to me because I view the credit aggregate statistics as being very important in helping make sense of things.
eg. just from what I've listed above one can conclude that much more money is being used for speculation in 2017 than was in 1988.
eg. Govt fiscal deficits and QE are not inflationary if private sector credit growth is contracting.

In terms of Ray Dalios' view of the economic machine might be a bad sign for farm prices that credit growth in that sector has turned -ve.
With Dalios simplistic approach, the ideas that can be applied to a sector can be applied to the whole economy..

just my view.... I've learnt there are very diverging points of views when it comes to economics and even more so when it comes to views on the nature of our monetary system...etc.

So Keith, would you say mortgaged property is the best asset to own?

It has certainly been a great asset to own in recent times - in most cases. But the future does have potential to be a lot more messy.

" to turn unemployed resources into productive resources "

This writer shows no sign, whatever, that he understands that we live on a finite planet. How many times have I ?

Sigh. Keith, it's about energy, efficiencies, finite resources/habitat and population. Collective called Limits to Growth. The economists you quote (why, at this late stage, are you still referencing stateroom-sogginess-measurers when the ship is clearly sinking?) have been long discredited in my circles - but we were the ones pointing out that peak extraction (essentially measured by peak energy because you need energy for work to be done) would mean that interest-charging was overshot. Simply put, as we start to descent the right-hand side of the graph, growth-bets are off. And they'll be lagging the underwrite, being forward bets. Too effing obvious - so why this dated piece?

You are quite right about taking local control, but debt-betting on the future has to go too.

QE is consuming our Future

QE generated Human behaviour ...... "All we seem to be seeing, pumped by QE combined with an exceptionally low OCR, is a flight to the ponzi-style share market and the long-term safe haven of property"

Yesterday it was a game of chasing the dime, buying property, ratcheting prices ever upward

Today is a new game, capital protection, buying property and other assets, ratcheting prices ever upward

The casino chips remain the same

There are some misunderstandings in this article as to how the governments finances operate. QE is not a means to finance the government and it does not do so, nor does it give the banks more money to lend. All government spending is made issuing new currency and crediting bank accounts, bank reserves are thus created and which are later reduced by the issuing of government bonds. QE is a mechanism to repurchase these bonds and return the reserves back to the banks again.
Banks create new money when they lend and they do not use their reserves except in their exchange settlement accounts. Economist Prof Bill Mitchell explains the banking system here.

Banks are using their exchange settlement accounts at the RBNZ all the time. It is a real time operating system. So the notion that banks 'do not use their reserves except in exchange settlement accounts' is technically correct (as this is the way that they operate all the time) but misunderstands their importance (for exactly the same reason - they are being used all of the time and lie at the heart of the system).

I agree, I was pointing out that banks do not lend out their reserves and so they have no effect on the money supply. Banks are not reserve constrained in their lending.

The banks are indeed constrained in normal times by the reserve ratio that they must maintain. But these are not normal times. They hold excess deposits relative to the demand for lending and these excess deposits go straight into reserves. This is the flood of capital and consequent lowering of interest rates as supply and demand play out.

There are no reserve requirements on the NZ banks lending, they only have capital requirements. Capital is retained profits and shareholder funds.

A couple of thoughts.

The reduction in the mortgage rates in my view isn't seeing more money in folks pockets, rather as mortgages are slowly reset lower against the background of wage cuts and redundancies it's a zero sum game. I.e. folks dont actually have more money in their pockets, they have less and they are spending less. This is going to get a whole lot worse when the wage subsidy winds up.

The reduction in rates has slowed / prevented some households going under. So in this respect QE is simply helping folks keep their heads above the water.

The question isnt answered above regarding the impact if QE is scaled back and rates rise, particularly new mortgage lending.

Our economy is so housing bubble dependent that should asset prices, particularly residential property, fall considerably more than the forecasts, we will likely see a cliff edge drop in consumer spending and Ue to match.

This is presumably why RBNZ are conducting the QE program and why it would be sensible to continue in the absence of viable alternatives.

You clearly don't have a mortgage, I used to pay 8.5% interest, now 2.5% that's a saving of $60'000 for every $Million mortgage, it's indeed "putting more money in the pocket of folks" as you say

Great article Kieth -thanks.

Some comments; the comments by the senior official of the RBNZ (under Chatham House rules although a long time has since passed!) but I read them as effectively an admission by the bank, and therefore ultimately the Government that the means to effectively control and manage the economy has effectively been surrendered to the 'market'! Surely this is an abandonment of the Government's responsibility?

You talk about little doubt that QE is contributing to declining interest rates, and to my mind imply inflation. however I see an unbalanced economy where there is significant inflation in one part of it, which you later refer to as a 'non-tradeable' - housing. In part i am trying to reconcile MMT theory with what you have produced here, and wonder if the MMT perspective to excess money in the economy leading to inflation is still correct, but that the trading banks are acting like a magnet to this money and are using it to shore up highly inflated housing costs.

What do you think?

If the banks were to actually lend this money rather than building reserves (( because they cannot find enough lending opportunities that satisfy their risk criteria), then housing prices would rise even further. I think the answer has to be for the RBNZ to leave more Treasury bonds in the market and let interest rates rise somewhat, combined with a restriction on the proportion of Treasury bonds that can be held by overseas entities.

The banks could be regulated to lend predominantly to the productive sector and RWA bank capital reduction regimes which encourage bank lending to the residential property sector should be abolished.

Maybe Keith is unaware the Aussie banks can lend 3 times (?, I think it was 4 x, but is now 3x) as much to residential as they can to business. The hidden methodology of risk weighting smoke and mirrors is pretty repulsive.

Around 60% of NZ bank lending is dedicated to residential property mortgages held by one third of households.

I think the answer has to be for the RBNZ to leave more Treasury bonds in the market and let interest rates rise somewhat.

Large US banks cannot get enough pristine collateral in the form of sovereign debt on their balance sheets to support lesser quality repo collateral trades and as a liquidity buffer. Debt to the penny is gigantic and sovereign debt yields are near record lows in the US.

I believe our banks are currently quite happy to build central bank reserve levels stashed on the RBNZ's balance sheet and play the derivatives markets. As I noted recently on another thread:

by Audaxes | 23rd Jul 20, 4:29pm
There seems little doubt that the Government deficit is increasing, and debt is forecast to increase by a large amount over the next few years, perhaps by $60 billion. Once again we should be grateful to the savers, for by providing money at low interest rates they are preventing worse outcomes.

Are banks not underwriting government debt issuance by writing up both sides of their balance sheets - ie banks purchase government's IOUs (bank asset) with their own IOUs (government deposit)? Government spends the deposit into the economy via transfer payments, banks swap fixed interest rate government bonds, via RBNZ QE, for floating rate government debt. Thereafter, banks elect to receive fixed in the IR swap market hoping RBNZ government bond purchases spur lower term government bond yields and increasingly negative IR swap yields. Or a deflationary economic outlook may do the job for both the RBNZ and banks and they just follow market interest rates down.

This is an interesting read that suggests "while lower rates indeed stimulate spending and lead to lower savings, this effect peaks at around 4% and then goes negative. In fact, if the lower yields and rates drop below 4% - not to mention to 0% or below - the lower the propensity to spend and the higher the savings rate" Go to:

Yes, Chart 5 says it all.
That is an amazing chart from the BoA.

Thus, the decline of interest rates to zero corresponds with a monetary imbalance in favor of deflation, if at least an abundance of deflationary pressures. This is something that Milton Friedman also talked about, particularly in 1998 with regard to Japan. He called it the interest rate fallacy, meaning that low nominal interest rates signify "tight" money conditions, or what would be consistent with significant deflationary pressure. It is and remains a fallacy because economists like those at every central bank around the world have decided instead that low rates are only "stimulus."

To correct this view, Friedman pointed out the basic, non-trivial distinction between a liquidity effect and an income effect. Low rates can be stimulative in the short run (the liquidity effect), but over the long run their persistence means something far different. A yield curve is supposed to be upward sloping given the core time value of money and investing. That arises from opportunity cost, meaning the more plentiful the opportunities the greater the time value and the steeper the curve (the income effect). Yield and/or money curves (the eurodollar curve and even the history of the OIS curve) that collapse and remain that way unambiguously demonstrate that "stimulus" deserves only the quotation marks.Link

I think Snider is taking Milton Friedman's comments out of context.
Also "the term "has been" refers to a period in the past.
Friedman said "“Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy. "

I think friedman is simply making the distinction between the quantity of money and interest rates.
In normal business cycles... higher fed funds rates precede recessions and lower fed funds rates precede recovery.... in a loose way
If there is a decent spread between low interest rates and returns on investments.... then of course, low rates are stimulatory.

Deflationary depressions are extraordinary and nobody expects the FED to work miracles..?? Banks have to spend time healing balance sheets... Credit worthy borrowers have to reappear... fear has to shift to hope ..etc..etc ( then ... we get growth in money supply )
(Ultra low interest rates , in themselves, ain't going to make all that happen.)

See my comment further up the page - referencing Prof. Werner, if I understand you correctly.

by Audaxes | 25th Jul 20, 10:52am
Can low interest rates really stimulate the economy?
The data suggests overall that statistical causality runs from economic growth to long-term interest rates. Nominal GDP growth provides information on future interest rates better than interest rates inform us about future nominal GDP growth.

Our empirical findings reject the canonical view that interest rates somehow affect economic growth, and in an inverse manner. To the contrary, long-term and short-term interest rates follow the trend of nominal GDP, in the .same direction, in all countries examined. This suggests that markets are not in equilibrium and the third factor driving GDP growth is a quantity – as shown by Werner, 1997, Werner, 2012a in the case of Japan (namely, the quantity of bank credit creation for the real economy - i.e., for GDP transactions, as the Quantity Theory of Credit postulates; Werner, 2013a). Link

i will read the Werner article.
This is What Milton Friedman says ( which makes sense to me )

History has already persuaded many of you about the first limitation. As noted earlier, the failure
of cheap money policies was a major source of the reaction against simple-minded
Keynesianism. In the United States, this reaction involved widespread recognition that the
wartime and postwar pegging of bond prices was a mistake, that the abandonment of this policy
was a desirable and inevitable step, and that it had none of the disturbing and disastrous
consequences that were so freely predicted at the time.
The limitation derives from a much misunderstood feature of the relation between money and
interest rates. Let the Fed set out to keep interest rates down. How will it try to do so? By buying
securities. This raises their prices and lowers their yields. In the process, it also increases the
quantity of reserves available to banks, hence the amount of bank credit, and, ultimately the total
quantity of money. That is why central bankers in particular, and the financial community more
broadly, generally believe that an increase in the quantity of money tends to lower interest rates.
Academic economists accept the same conclusion, but for different reasons. They see, in their
mind’s eye, a negatively sloping liquidity preference schedule. How can people be induced to
hold a larger quantity of money? Only by bidding down interest rates.
Both are right, up to a point. The initial impact of increasing the quantity of money at a faster
rate than it has been increasing is to make interest rates lower for a time than they would
otherwise have been. But this is only the beginning of the process not the end. The more rapid
rate of monetary growth will stimulate spending, both through the impact on investment of lower
market interest rates and through the impact on other spending and thereby relative prices of
higher cash balances than are desired. But one man’s spending is another man’s income. Rising
income will raise the liquidity preference schedule and the demand for loans; it may also raise
prices, which would reduce the real quantity of money. These three effects will reverse the initial
downward pressure on interest rates fairly promptly, say, in something less than a year. Together
they will tend, after a somewhat longer interval, say, a year or two, to return interest rates to the
level they would otherwise have had. Indeed, given the tendency for the economy to overreact,
they are highly likely to raise interest rates temporarily beyond that level, setting in motion a
cyclical adjustment process.
A fourth effect, when and if it becomes operative, will go even farther, and definitely mean that a
higher rate of monetary expansion will correspond to a higher, not lower, level of interest rates
than would otherwise have prevailed. Let the higher rate of monetary growth produce rising
prices, and let the public come to expect that prices will continue to rise. Borrowers will then be
willing to pay and lenders will then demand higher interest rates—as Irving Fisher pointed out
decades ago. This price expectation effect is slow to develop and also slow to disappear. Fisher
estimated that it took several decades for a full adjustment and more recent work is consistent
with his estimates.
These subsequent effects explain why every attempt to keep interest rates at a low level has
forced the monetary authority to engage in successively larger and larger open market purchases.
They explain why, historically, high and rising nominal interest rates have been associated with
rapid growth in the quantity of money, as in Brazil or Chile or in the United States in recent
years, and why low and falling interest rates have been associated with slow growth in the
quantity of money, as in Switzerland now or in the United States from 1929 to 1933. As an
empirical matter, low interest rates are a sign that monetary policy has been tight—in the sense
that the quantity of money has grown slowly; high interest rates are a sign that monetary policy
has been easy—in the sense that the quantity of money has grown rapidly. The broadest facts of
experience run in precisely the opposite direction from that which the financial community and
academic economists have all generally taken for granted.
Paradoxically, the monetary authority could assure low nominal rates of interest—but to do so it
would have to start out in what seems like the opposite direction, by engaging in a deflationary
monetary policy. Similarly, it could assure high nominal interest rates by engaging in an
inflationary policy and accepting a temporary movement in interest rates in the opposite
These considerations not only explain why monetary policy cannot peg interest rates; they also
explain why interest rates are such a misleading indicator of whether monetary policy is “tight”
or “easy.” For that, it is far better to look at the rate of change of the quantity of money.
page 4-5

The context of Friedmans point of view were the inflationary world of the 1960s and 1970s. Part of his argument is rising prices.

I think academics can be tooo academic. Just as raincoats sell in winter and not so much in summer.... lower interest rates stimulate GDP growth when there is a demand for credit and at the least ..... Don't you agree..?

Exactly. Higher interest rates raise the bar for investment decisions, thus only the most productive are encouraged. Over time society becomes more productive and wealthier.

Low interest rates encourage the spending of the accumulated wealth of society and over time society becomes less productive and poorer.

Large bureaucratic organisations, public and private, like low interest rates as they benefit via hidden wealth transfer effects. SMEs focus on wealth generation via profits and positive cash flow. Large organisations focus on maintaining their privileged access to wealth transfer processes, ie toll booth effects.

Ya gotta laugh ......
From your Friedman quote above: "That is why central bankers in particular, and the financial community more broadly, generally believe that an increase in the quantity of money tends to lower interest rates. Academic economists accept the same conclusion, but for different reasons. They see, in their mind’s eye, a negatively sloping liquidity preference schedule."

The Academics - Of course they would

"A lie can travel around the world and back again while the truth is lacing up its boots"

QE does not lower interest rates. It increases them. I am amazed how conventional wisdom can be so wrong, for so long, and how everyone falls for it.

QE creates the expectation that things will improve (anyone been bemused by rising share markets in the US and elsewhere lately?) and that raises rates.

Yes, rates are often lower post QE than before whatever crisis precedes it. However, without QE, among other monetary and fiscal measures, rates would be an awful lot lower still.