Unconventional Monetary Policy
Economics (Year 12) - Monetary Policy
What is unconventional monetary policy?
In March 2020, the Reserve Bank of Australia announced that it would commence using other instruments, in addition to the cash rate, in order "to lower funding costs and support the supply of credit." (RBA, 2020)
The RBA adopted unconventional measures due to the ineffectiveness of traditional monetary policy during a trough, which is a result of the "liquidity trap"; as when interest rates are low, and unemployment rates are high, the economic outlook is bleak, and despite the low interest rates, consumers are still not borrowing or spending; they lack confidence.
The RBA announced four main unconventional measures:
A term funding facility to deposit-taking institutions
Changes to interest rates of exchange settlement accounts by authorised deposit-taking institutions
Quantitative Easing (QE)
This is a technique that the RBA can use to control the money supply which does not use the cash rate.
The government sells bonds on the primary market to obtain funds for spending, and these bonds can then be resold on the secondary market between individuals and institutions.
If the government chooses to buy back securities on the secondary market, then it will pay with funds held at the Reserve Bank and not in circulation into the bank accounts of either institutions or individuals, where it forms the basis of bank lending and therefore increases the supply.
Conversely, if the government sells more securities, individuals and institutions pay for the bonds with money from their bank accounts and the bonds are transferred to them, and their money is deposited into the Reserve Bank. This money is now out of the banking system, and banks will need to recall loans or cease lending, therefore the money supply is reduced.
QE has risks however; it can push up asset prices if the cash pumped into the economy increases the demand for housing or shares in public companies, and can reduce the incentive to save as it drives interest rates lower.
Term Funding Facility (TFF)
The Reserve Bank provides a medium term fixed interest facility for deposit taking institutions at 0.25% for 3 years to assist financial institutions to be confident about their access to funding, and to lower their funding costs, which can be passed on as lower household and business borrowing costs.
The RBA announced a $90bn TFF, and of that in 2020, banks lended $52bn.
The Reserve Bank issued notice that the short to medium term (approximately 3 years) future would be one of low interest rates, and that this would remain to be the case until inflation reaches the 2 to 3% range. The predominant focus is now on reducing levels of unemployment.
Changes to interest rates of ESAs by ADIs
The new cash rate as of March 2020 is 0.1%, and this has been put in place in order to minimise the costs to banks in performing normal business operations, so that they can lend at the most competitive rate to businesses in order to encourage investment and growth in employment.