Outgoing Reserve Bank governor Philip Lowe defended himself in a speech last week against what he sees as unfair criticism of the bank’s COVID response, and attempted to correct the record on what he believes is inaccurate reporting in the wake the pandemic.
Perhaps the best way to assess the RBA’s performance during and after the pandemic is to draw on its own reviews of its performance. Over the course of last year, the bank published a series of documents, giving itself a mixed report card for the four unconventional monetary policy tools it used during the pandemic.
The following article was first published in Banking Day on December 12, last year.
The unconventional policy measures the RBA adopted during the pandemic were designed to meet the bank’s goals when it could no longer use the cash rate, which had gone as low as it could go.
In summary, it is unlikely to use yield targeting again, it needs to refine its use of forward guidance, its bond purchasing program was effective but very costly, and it rated the Term Funding Facility a success.
Strong forward guidance: The RBA had used forward guidance before the pandemic, with the guidance generally qualitative in nature. It was more specific during the pandemic and included a “time-based element”.
The RBA said that together with other policy measures, the forward guidance worked to lower funding costs and support the economy early in the pandemic, when the outlook appeared dire.
It said the time-based element of the guidance was very prominent in media and market commentary and came to dominate the forward guidance. This complicated the RBA’s attempts to communicate the “state-based” nature of its policies (that is, the economic conditions that would determine cash rate changes).
“The time-based element of the guidance, like the term for the yield target, was not well suited to respond to events,” it said.
The RBA has not ruled out using a strong form of forward guidance again but in future it would probably leave the markets and the public to draw their own inferences about the timing and extent of future interest rate movements.
It will also make the guidance more flexible, using a range of scenarios.
Bond purchasing program: The bond purchasing program was introduced in November 2020 and ultimately involved the purchase of a total of A$281 billion of commonwealth, state and territory government bonds up to February this year.
The program contributed to lower interest rates by lowering government bond yields, as well as supporting good functioning in the bond market and, more generally, boosting confidence in the economy.
The RBA said the program worked broadly as expected without materially affecting market functioning. Compared with a yield target, a bond purchasing program provides more flexibility to respond to evolving economic circumstances.
However, it conceded there was a large financial cost. The purchased bonds pay a fixed return to the RBA, while the interest paid on the exchange settlement balances created to pay for the bonds varies with monetary policy settings. As interest rates have gone up, there has been a cost to the RBA.
The RBA does not expect to pay a dividend to the government for several years.
Yield targeting: The RBA conceded that its exit from its three-year government bond yield target in late 2021 was “disorderly” and caused the bank some reputational damage. It also accepted that purchases to defend the yield target came at a financial cost given the subsequent rise in yields.
While it argued that the yield target contributed to insuring against extreme downside risk by lowering funding costs and reinforcing other key elements of its package of COVID policy measures, it said it could have been ended the program earlier.
In March 2020, the RBA introduced a target for the yield on three-year Australian government bonds of around 25 basis points. At the time, the three-year bond had a maturity of April 2023.
The yield target was viewed as an extension of and complement to the cash rate target and the three-year maturity was chosen because of its importance as a benchmark rate in financial markets.
In September 2020 the RBA said it would move the yield target from the April 2023 bond to the April 2024 bond, and in November the target was lowered from 25 bps to 10 bps, in line with a reduction in the cash rate target to that level.
In November 2021, the RBA discontinued the yield target.
The RBA said that in its decision-making it paid close attention to the downside risks to employment and inflation, with a focus on providing insurance against very bad outcomes.
“In retrospect, a greater focus on the upside could have led to a decision not to extend from the April 2023 bond to the April 2024 bond or earlier removal of the target,” it said.
“Its effectiveness as a monetary policy tool waned as market participants reassessed their views on the outlook for the cash rate. In the later part of the targeting period, the transmission of the target to other interest rates in the economy weakened, with market rates of similar maturity moving materially away from the target government bond rate.”
In describing its exit as “disorderly”, the RBA was referring to the fact that in October 2021 the yield on the April 2024 bond rose as high as 77 bps, as a stronger than expected inflation number, an increase in yields globally and an absence of RBA buying were taken as signs that the target would be discontinued.
“In retrospect, given the evolution of inflation and the labour market, an earlier end of the yield target would have been appropriate. Any yield target should be short enough to sustain very high confidence that the target can be maintained.”
The RBA said the likelihood it will use a yield target again is low but it might be appropriate in extreme circumstances.
“It is likely that in the future, bond purchases would be preferred to a bond yield target. While a bond purchase program may not be as effective in achieving a specific risk-free yield, bond purchases put downward pressure on yields and the exchange rate.”
“Importantly, bond purchase programs provide greater flexibility on exit and help avoid some of the exit issues associated with the yield target.”
Term funding facility: The TFF was launched in March 2020, initially giving banks access to three-year funding at a cost of 25 basis points. The initial allowance was 3 per cent of each bank’s total credit outstanding. In September 2020 the program was expanded with a supplementary allowance for each bank and in November the rate was lowered to 10 bps. The total allowance was equivalent to 4 per cent of their non-equity finding or 6 per cent of their total credit.
Banks used the facility to borrow $188 billion – 88 per cent of the total funding available under the terms of the program. Ninety-two of the 133 eligible banks accessed the TFF. Generally, those that did not use the scheme were not able to access eligible collateral at a low cost.
The RBA said the TFF contributed to a decline in banks’ funding costs. This was achieved in a couple of ways: the TFF itself was a low-cost source of funds; and less reliance on wholesale funding narrowed the spread on bank bonds.
The decline in funding costs was passed through to lending rates.
The TFF’s additional allowance was tied to increased business lending. A bank was provided with $1 of additional funding for every extra dollar it loaned to large businesses, and $5 for every extra dollar it loaned to SMEs.
The RBA said the effectiveness of the additional allowance in supporting business credit growth is hard to assess. Overall business lending was little changed, with lending by a number of banks declining. But there were other factors that influenced demand for business credit during the period.
However, business credit held up better during the 2020 downturn than during the global financial crisis and earlier recessions. “At least part of this difference may be attributed to the incentives to lend to business under the TFF.”
Overall, the RBA’s view is that the TFF met its goals, supporting low funding costs for banks, helping stabilise funding markets, providing banks with funding certainty and contributing to lower lending rates.
Non-bank lenders were critical of the RBA for providing such cheap funding to banks and giving them a competitive advantage.
The RBA does not accept this. It said that, as banks stayed out of the RMBS market, the TFF indirectly contributed to reduced spreads on securities issued by non-banks. Non-banks responded by issuing large volumes of RMBS and grew their market share.
It also pointed out that non-bank lenders received government support through Structured Finance Support Fund.