Finance Minister Grant Robertson acknowledges the Reserve Bank’s (RBNZ) bond-buying, or quantitative easing, is likely to come at a larger cost than expected at the start of the pandemic.
The Treasury last week estimated rising interest rates would see the cost of the Large-Scale Asset Purchase (LSAP) programme hit $5.1 billion. It was initially expected to be cost-neutral.
Robertson said that when the Crown agreed to indemnify the RBNZ for losses incurred by the programme in March 2020, he was aware of the risk involved. But he decided it was a “risk worth taking”.
He wouldn’t say whether he would support using bond-buying in the future, should a change in economic conditions prompt the RBNZ to decide to go down this path again.
The LSAP programme saw the RBNZ buy $53.5 billion of New Zealand Government Bonds on the secondary market between March 2020 and July 2021. It did so to lower interest rates to boost inflation and employment, as well as to support smooth market functioning.
The programme was always going to come at an upfront cost to the Crown. This is because the RBNZ would be buying government bonds from banks and other investors at a time bond yields were falling. Thus, the RBNZ would be paying a premium to effectively buy at the top of the market.
The Treasury estimated upfront losses of $7.2 billion would be offset by the savings the programme would deliver to the Crown’s debt servicing costs.
But as it turned out, the economy rebounded more quickly than expected. Inflation is rising and interest rates aren’t being kept at emergency lows for long enough for the Crown’s interest cost savings to fully offset the upfront cost of the LSAP programme.
The cost of the LSAP programme won’t be known until 2027, when the programme is expected to be completely unwound. But, the Treasury expects the net cost to land at around $5.1 billion. See last week’s story for a more detailed explanation.
While this is a significant sum, it doesn't consider the broader economic impacts of low interest rates, including how they supported economic demand, which boosted the government's tax take and the value of its assets (financial investments, land, buildings, etc).
The difficulty is knowing the extent to which other less costly tools used by the RBNZ to lower rates supported the economy versus the LSAP programme.
Risks were known
Robertson acknowledged that when he agreed to backstop the RBNZ, in respect of LSAP programmes losses, in March 2020, the expectation was for the economy to recover from Covid-19 slowly, and for interest rates to remain lower for longer.
Indeed, the LSAP programme was launched at least in-part due to the fact the economic outlook was as dire as it was uncertain, and there wasn’t much room to cut the Official Cash Rate without going into negative territory.
However, the Treasury in late-January 2020 warned Robertson bond-buying would make the Crown’s balance sheet more exposed to rising interest rates.
The Treasury provided a “red” (rather than “orange” or “green”) level trade-offs warning of the potential for the RBNZ to suffer “significant financial losses”, depending on the amount of bonds it bought.
It noted the RBNZ's Monetary Policy Committee isn’t formally required to consider “fiscal risks” associated with bond-buying. It just needs to "have regard to the efficiency and soundness of the financial system".
Furthermore, the Treasury warned bond-buying could “disproportionally benefit” those the RBNZ buys bonds from - IE the banks.
“Risk will also depend on whether the Bank has a credible exit strategy,” it said.
“To date, no central bank that has undertaken large scale asset purchases has effectively unwound their purchases.”
The RBNZ is endeavouring to unwind the LSAP programme by selling down its bond holdings between July this year and 2027.
Asked whether he still stood by his decision to support the LSAP programme, Robertson noted he didn’t have the “luxury of hindsight” in 2020.
“We had to take the decisions we did with the information we had at the time. I’m not going to change my thinking on that,” he said.
Robertson also noted, in the same exchange he had with interest.co.nz on the LSAP programme, that house prices had risen more than expected at the start of the pandemic.
The Treasury's January 2020 advice warned of this eventuality.
It gave a red level warning that bond-buying “may increase wealth inequality by more than conventional monetary policy by raising asset prices more directly”.
“On the other hand, a stable macroeconomy supports those at the edge of the labour market,” the Treasury said.
Like fiscal risks, the Treasury noted the RBNZ isn't directly responsible for dealing with the distributional impacts of its monetary policy, provided it has regard to the "efficiency and soundness of the financial system". See this story from February 2021 for more on this issue.
*This article was first published in our email for paying subscribers. See here for more details and how to subscribe.