The $55b question: Was the Reserve Banks QE programme worth the money?

The Reserve Bank’s version of quantitative easing (QE) – buying Government bonds to suppress interest rates – came to $55 billion by the time it stopped in July.

It was the central bank’s first stab at QE – the practice having been being heavily leaned on by the US Federal Reserve in the aftermath of the Global Financial Crisis.

Early in 2020, the Reserve Bank and central banks around the world joined the QE pack when Covid-19 first emerged as a serious threat to their economies.

As it has turned out, the New Zealand economy performed remarkably well, despite the challenges posed by the pandemic.

While often glibly described as “money printing” the Reserve Bank’s large-scale asset purchase programme (LSAP) is still debt – money that will need to be paid back further down the track.

With the benefit of hindsight, was the Reserve Bank’s $55b QE programme worth the money?

“At the time, undoubtedly, there was the real motivation to throw the kitchen sink at it because we didn’t know with Covid,” ASB Bank economist Mark Smith says.

Looking back, Smith argues that a more targeted, fiscal approach would have been more appropriate rather than the broad-brush monetary response offered by QE.

“If you knew then what you knew now, you would probably say: yes the economy does need support, but it also needs more targeted support, providing more of a leg-up to some of those [affected] sectors,” he says.

If faced with the same situation, he doubted the Reserve Bank would go down the QE route again.

The counterfactual

But as Capital Economics economist Ben Udy says, it’s difficult to know what the counterfactual would have been. In other words, what would have happened if the Reserve Bank had done nothing?

“Certainly if you asked the bank, they would say that they did not make any mistakes.

“And it’s only with the benefit of hindsight that you can really look at this question.

“I think if the bank were put in the same situation again, they would probably do the same, and I think that’s the right call.

“Was this the cheapest way to deliver as much stimulus as they did – maybe not.”

Udy noted that the Reserve Bank of Australia initially put in place a yield curve target – which was cheaper initially – before it too began buying bonds in much the same way as RNBZ did.

By Udy’s reckoning, the amount of stimulus delivered by New Zealand’s brand of QE was appropriate.

“The economy has now bounced back to be one of the strongest economies worldwide.”

However, Udy did not give the Reserve Bank an A-plus report card for its pandemic performance.

Where there was a misstep was the ending of loan to value (LVRs) restrictions to try to support the housing market during the pandemic.

By December that year, the Reserve Bank was rowing back on that move.

“Obviously, they did not know what was going to happen to the housing market.

“Most economists, including ourselves, thought house prices were going to drop, so they scaled back LVRs to reduce the economic fallout.

“They managed to avoid any fallout from falling house prices but I don’t think – even if they had not removed those LVRs – that the house prices would have crashed.

“They didn’t crash anywhere – really – and now house prices are so strong that I would suspect that they would prefer to not have done that.

“That’s the one piece of stimulus that they should not have done, with the benefit of hindsight, but on QE the bank went hard and fast, and they will probably be pretty happy about that,” Udy said.

At the coal face

In the financial market dealing rooms, it was a matter of the Reserve Bank coming to the rescue of the bond market, which had become dysfunctional to the point of grinding to a halt early in 2020.

“QE, which has had a limited history around the world, has always had its maximum effect at the beginning and the effect tends to wane over time, so the marginal impact does lessen,” Westpac senior market strategist Imre Speizer said.

“They did cause bond yields to fall and then, as they continued, the programme had less and less effect.”

By Westpac’s analysis – comparing the first six months with the second – the stats suggested the second period was less effective than the first.

“By the time that they ceased business, I think they felt that it was not having much impact.”

As it turned out, the extremely dire economic predictions did not eventuate.

“The economy panned out nowhere near as first thought, but the Reserve Bank did the prudent thing considering there was so much uncertainty,” Speizer said.

“You have to use the tools that you have at your disposal and use them boldly as a first step, and that’s exactly what they did.

“Did they end up doing too much in an economy that only weakened a bit – that’s a separate question – and I really don’t have an answer for that.”

Speizer said the big question now facing the market is what will the Reserve Bank do with its massive bond portfolio.

Puked

Harbour Asset Management fixed income and currency strategist Hamish Pepper said the market, faced with the turmoil of Covid-19 and the likelihood of a huge borrowing requirement from the Government for the likes of the wage subsidy schemes had “puked” at the prospect.

Quite apart from the need for monetary policy stimulus, the functioning of the markets needed to be addressed.

The market had done what it typically does during a crisis.

There were too many sellers of bonds for the market to absorb, so the spread between the bid and the ask widened to the point where trading effectively stopped.

Pepper, a former senior analyst at the bank, said the bank did a good job with QE.

“They did not hesitate and when they saw that it had done the job. They stopped it quite suddenly and without any fanfare”.

For those at the coal face, he said the sheer size and scale of QE at the beginning was needed.

“There was some very strange price action. We had been hit by this huge shock, which we knew was going to be harmful.

“There were moments when the bond market was broken.

“It may have found equilibrium naturally but it would have taken time and would have been a high level in yield.

“So what the Reserve Bank’s LSAP programme was able to do was accelerate the process of normalisation of the market, which was good for Treasury’s debt management issuing debt into it, and kept that funding source available.

“The other part of it was to actually lower the cost of that funding.”

Pepper supported the Reserve Bank’s actions.

“If you think about what we were worried about when Covid hit, then yes those issues were not insignificant – not at all.

“But we did avoid something that could have been quite damaging and quite long lasting, so the policy response was a critical part of avoiding that.”

What now

With the Reserve Bank now being the proud owner of $55b worth of Government bonds, what happens next?

The bank, in its last monetary policy statement, noted that the LSAP programme provided significant monetary stimulus and supported a functioning bond market through 2020.

“As bond market functioning has improved, the impact of the LSAP programme on monetary stimulus has fallen, and it is assessed that current bond holdings are providing a small amount of ongoing stimulus,” the monetary policy committee said in notes accompanying the November statement.

The committee expects to gradually manage LSAP bond holdings down, in a way that maintains the smooth functioning of financial markets.

More details on how bond holdings will be reduced will be revealed in February.

While bond purchases ceased in July, the bonds purchased have maturity dates going out as far as 2041.

While the time-frames are very long, this portfolio will need to be managed, and how that is done is important to financial markets, ANZ said.

The bank said unwinding the LSAP portfolio will have to be done in a flexible and pragmatic manner, with decisions dependent on how the economy and bond markets evolve.

“We don’t think the LSAP portfolio will be a permanent feature of the market’s landscape, but it could be with us for some time, with the global experience suggesting that getting out of QE gracefully is a lot harder than getting in.”

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