There really is no such thing as a free lunch. I will explain why.
In March 2020, the federal government announced that Australia was facing health and economic crises.
Both have cost the country dearly.
But one aspect of the economic response seemed too good to be true. As the crisis unfolded, the Reserve Bank announced that it was embarking on a money-printing program, also known as quantitative easing.
It is an unconventional policy, with a country’s central bank creating new money to buy government bonds from commercial banks.
The process stimulates the money supply, lowers interest rates and prompts commercial banks to increase their lending.
I wonder though, have you ever wondered who would end up having to pay for this program?
Everything has a price in the end, it’s only a matter of time.
The RBA and the economic bailout
The Reserve Bank has a vital role to play in helping run the economy at all times, let alone a single pandemic.
Its set of policies over the past two years has been comprehensive, but there are two aspects of this policy toolkit that concern you directly.
The first is that it has kept its cash rate target at the all-time low of 0.1% since the onset of the economic crisis.
The second is that he literally typed extra zeros on his computer terminals at his head office in Sydney’s Martin Place in order to create the money with which he bought billions of dollars in government bonds every week from the commercial banks – now totaling over $ 320 billion.
It is quantitative easing.
As a result, commercial banks have fewer bonds on their books and more money to lend (money received by the RBA) – and an incentive to do so since they only earn 0.01% on that at the end of the day. Reserve bank.
But what is the cost?
Here is the thing. Tens of billions of dollars of bonds are still held by the Reserve Bank and the money used to pay them into commercial bank accounts with the RBA.
What if, what if, the interest rate on the commercial bank’s deposit account with the RBA (foreign exchange settlement account) increases?
Of course, the Reserve Bank would have to pay the additional interest to the commercial banks.
As of Wednesday, December 29, trade settlement balances stood at $ 428.7 billion.
Independent economist Saul Eslake has studied the Reserve Bank’s financial accounts in detail.
“Before COVID, the Reserve Bank paid around $ 1 billion in interest, mostly to banks, on their foreign exchange settlement (ES) balances.
“[Those] balances were generally less than $ 30 billion at all times.
“He was getting around $ 2 billion a year in [coupon payments] on its bond holdings.
“[But now] the interest the bank pays on its very large ES accounts has fallen to almost zero.
“[The RBA] will likely earn even more interest on its large bond holdings, at least for a while, than it has to pay the banks interest on their ES balances, but it is clear that the Reserve Bank’s continued profits of this interest rate differential will decrease [as interest rates rise]. “
This means that, as the interest rates on those deposits rise enough, the Reserve Bank would start paying banks billions in interest – just like a bank pays you interest on your deposit account.
“It is conceivable that the Reserve Bank could start recording losses because of the narrowing of the gap between what it receives and what it pays,” he says.
What Mr. Eslake is saying is that the Reserve Bank is currently making money through its bond buying program, but once interest rates start to climb the bank may start to rise. bleed money by paying more to commercial banks than it receives from governments in terms of income from its bond holdings.
What if RBA starts to bleed money?
The Reserve Bank, like any bank, is a business.
When it suffers losses, it seeks to “recapitalize” or seek debt and equity (more money) to maintain its stable position.
One “investor” the RBA relies on is the government, according to former Treasury economist Warren Hogan.
“Yes [the RBA’s] the losses are quite significant, they destroy their profits and also their reserves, they will have to be recapitalized, ”he said.
“These are government funds.
“It will be an appropriation of general government revenues.”
In a rising interest rate scenario where the RBA suffers enough losses under its bond buying program, the government would have to use taxpayer funds to recapitalize the bank.
You, the taxpayer, would start paying for the spinoffs of the RBA’s printing money program.
This is not happening yet. But 2022 is shaping up to be another tough year globally and the RBA has a lot to juggle.
What are the possible damages?
Short answer? Billions.
“The Reserve Bank’s exposure to the underlying financial system is far greater than it has ever been in its history,” Professor Hogan said.
“If interest rates change, then the Reserve Bank’s exposure to it would easily measure in the billions or even tens of billions.”
The Reserve Bank has helped the economy with its money-printing program, but as Professor Hogan says, “quantitative easing doesn’t mean debt is eradicated, it just means you don’t. to immediately appeal to the private sector for these funds “.
“The debt will have to be repaid.
“It will either be reimbursed by taxes or reimbursed by the Reserve Bank.”
That’s not to say that QE wasn’t worth it, it most certainly averted economic disaster.
It’s just that it doesn’t happen in a vacuum.
The debt has been created and it will have to be managed and paid off.
When can all this happen?
We know that bank fixed rates are on the rise, but of course a crucial question is whether the spot rate will increase this year, which would affect the rates on ES deposits of commercial banks.
It depends on the RBA itself.
It is indicated that he will be patient and first wants to see a significant increase in wages.
However, the pandemic and supply chain issues are already pushing inflation up, which could force the Reserve Bank to raise the targeted cash rate sooner than expected.
And in the United States, which is ahead of us to see inflation rise, the Federal Reserve said this week that interest rate hikes could take place there as early as March.
Based on the RBA’s 2021 annual report, she doesn’t think she’ll need to appeal to the government for more funds.
When we asked the Treasury for a response, it indicated that the RBA’s capital can be replenished over time by retaining future profits, rather than through a capital injection (money from government revenue).
The multibillion dollar question is: what if interest rates were to rise significantly this year?
If they do, the taxpayer will have to pay billions.
Free meal? No chance.