Last week, the Reserve Bank of Australia governor, Philip Lowe, confirmed that the claim that the central bank is independent of the political process is a pretense. The Governor was adopting a political role and made several statements that cannot be analytically supported nor supported by the evidence available over many decades. He is insistent on disabusing the public debate of any positive discussion about Modern Monetary Theory (MMT), which, of course, I find interesting in itself. More and more people are starting to understanding the basics of MMT and are realising that that understanding opens up a whole new policy debate, that is largely shut down by the mainstream fictions about the capacities of the currency-issuing government and the consequences of different policy choices. People are realising that with more than 2.4 million Australian workers currently without enough work (more than a million officially unemployed) that the Australian government is lagging behind in its fiscal response. They are further realising that the government is behaving conservatively because it still thinks it can get back to surplus before long and so doesn’t want to ‘borrow’ too much (whatever that means). An MMT understanding tells us that the government can create as many jobs as are necessary to achieve full employment and the central bank can just facilitate the fiscal spending without the need for government to borrow at all. They are asking questions daily now: why isn’t the RBA helping in this way. The denial from the RBA politicians (the Governor, for example) are pathetic to say the least.
The occasion was the presentation of the RBA Annual Report 2019 to the – House of Representatives Standing Committee on Economics (August 14, 2020).
The full exchange is available in – The Hansard.
Here is the – Opening Statement to the House of Representatives Standing Committee on Economics – by the RBA Governor.
The RBA Governor is obviously under pressure given the scale of the damage being caused by the pandemic and the obvious shortfall in the fiscal response from the Australian government.
People are increasingly asking why is the RBA not using its infinite currency capacity to gave a speech where h
On July 23, 2020, he gave a very political speech along these lines, which I analysed in this blog post – RBA governor denying history and evidence to make political points (July 23, 2020).
I won’t repeat what I wrote there but I discussed the notion of a ‘free lunch’ and ‘inflation taxes’ and issues that the RBA governor raised again in his appearance before the House of Representatives’ Committee.
Here are some issues that arise from his appearance last Friday.
In his Opening Statement last Friday, the Governor chose to continue this deception, clearly aiming to avoid any Modern Monetary Theory (MMT) inference:
One monetary policy option that has been the subject of public discussion over recent months is the possibility of the RBA creating money to directly finance government spending.
For some, this offers the possibility of a ‘free lunch’.
The reality, though, is that there is no free lunch. There is no magic pudding. There is no way of putting aside the government’s budget constraint permanently.
As I spoke about in a talk last month, it is certainly possible for a central bank to use monetary financing to affect when and how government spending is paid for. Depending upon how things are managed, it can be paid for through the inflation tax, by implicit taxes on the banking system and/or higher general taxes in the future. But it does have to be paid for at some point.
I want to make it clear that monetary financing of the budget is not on the agenda in Australia. The separation of monetary policy and fiscal financing is part of Australia’s strong institutional framework and has served the country well. The Australian Government and the states and territories have ready access to the capital markets and they can borrow at historically low rates of interest.
So this is his repeating theme despite the fact that the RBA has already purchased $A45,250 million worth of Australian Government bonds under its so-called – Long-dated Open Market Operations.
I discussed this program in this blog post – The Australian government is increasingly buying up its own debt – not a taxpayer in sight (May 26, 2020).
The Government has not been saying much about this program for obvious reasons.
They don’t want the public to know that one arm of the currency-issuing government is accumulating a large proportion of the liabilities issued by another arm (Treasury) to follow the rise in the fiscal deficit.
If they explained what was going on in the real world to the public, it would become very clear that the central bank is effectively ‘funding’ a significant proportion of the increase in the fiscal deficit than any notion of some taxpayer account or the reliance on private bond markets.
It would also disabuse the public of notions that such coordination between the central bank and the treasury, which is at the heart of the understanding you get from learning about Modern Monetary Theory (MMT), is dangerously inflationary.
In their information sheet – Supporting the Economy and Financial System in Response to COVID-19 – the Reserve Bank of Australia outlines a number of policy innovations they are pursuing to help protect the economy and the financial system.
Among these measures they write:
Provide Liquidity to the Government Bond Market
The Reserve Bank stands ready to purchase Australian Government bonds and semi-government securities in the secondary market to support its smooth functioning. The government bond market is a key market for the Australian financial system, because government bonds provide the pricing benchmark for many financial assets. The Bank is working in close cooperation with the AOFM.
You can also view their more detailed explanation of what they are doing in this regard at – Reserve Bank Purchases of Government Securities.
As I explained in the blog post cited above, the RBA is crediting bank reserves (the Exchange Settlement Accounts (ESAs)) in return for bond purchases.
These bonds have been issued in the primary bond markets and then bought and sold generally in the secondary market where the RBA buys them.
In its explanatory note, the RBA seems they need to set up the smokescreen in this way:
The Bank stands ready to purchase Australian Government bonds across the yield curve to help achieve this target. The Bank purchases Government bonds in the secondary market, and does not purchase bonds directly from the Government.
They could have added – ‘As if any of that matters’!
The point is that the primary bond dealers can reasonably anticipate that the RBA will purchase debt from them.
The complete data set is available via the RBA statistics – Monetary Policy Operations – Current – A3 – then go to the worksheet “Long-Dated Open Market Operations”.
What do we learn?
Since March 26, 2020, when the purchases began, the RBA has purchased a total of $A45,250 million million worth of Australian government bonds (at varying maturities and yields).
Here is the pattern of purchases of Australian Government securities by the RBA since March 26, 2020.
In his interaction with the House of Representatives Committee, the Governor repeated the point made in his introductory with a more specific reference to MMT:
One monetary policy option that has been the subject of recent discussion is the possibility of the RBA creating money to directly finance government spending—so-called MMT. To some, this offers the possibility of a free lunch. The harsh reality, though, is there’s no free lunch. There’s no magic pudding here and there’s no way of putting aside the government’s budget constraint permanently.
He then went on to say: “But, looking forward, there are limits to what more we can do. I think the main policy instrument we really have now is fiscal policy.”
He was asked whether this means that monetary policy has run its course and he replied:
I don’t think that at the moment we would get any traction from making adjustments …
And then proceeded to make a series of political statements outside of his official role as central bank governor:
1. Reforming industrial relations – read, further deregulation that has already dramatically undermined the ability of workers to share in productivity growth, created a working poor underclass, cut the wages of the lowest paid, and more.
2. Further deregulation – to reduce oversight on private infrastructure projects, reduce “planning and zoning restructions” (read: make it easier for greedy property developers to invade neighbourhoods and build more towers that later have to be abandoned due to shoddy construction techniques).
He was asked by one Committee member whether the RBA should provide the government with “zero per cent loans” to fund a full employment program, given the scale of the labour market disaster and the stated claim by the Governor that the key issue facing Australia was job creation.
Readers are also reminded that the – Reserve Bank Act 1959 – Section 8, empowers the central bank “to buy and sell securities issued by the Commonwealth and other securities”, “to establish credits and give guarantees” and more.
Also note that under Section 10 Functions of the Reserve Bank Board, Clause (2):
It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank under this Act and any other Act, other than the Payment Systems (Regulation) Act 1998, the Payment Systems and Netting Act 1998 and Part 7.3 of the Corporations Act 2001, are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:
(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.
In other words, the legislative responsibility of the RBA is to maintain full employment with price stability so that all people in Australia are prosperous and secure.
The RBA governor replied to that question with this simpering nonsense:
There’s less cash flow expended in the short run; that’s right. You’re not paying interest on these bonds, and, if you issued in the market, you would have to pay interest. But now the central bank has an asset that’s earning no money, and then, over time, there will be lower profits at the central bank and lower distributions to government, and there will have to be a tax compensation for that. So it’s incorrect to think that providing this financing the other way ultimately lowers the total cost of finance. It doesn’t.
Which is a straight out lie.
This is right pocket of government talking to the left pocket of government stuff.
The RBA doesn’t have to earn money.
The RBA could pay the Treasury any amount it chose at any time.
There would not have to “be a tax compensation for that”. That statement assumes some rigid fiscal position has to be attained so that if the government doesn’t pay itself RBA profits as dividends it has to raise tax rates.
It never has to do that.
The discussion continued, with the Committee member demanding to know why the RBA wouldn’t just fund a full employment program.
The Governor replied:
I take issue with the idea that the government can borrow more cheaply through us. Certainly, the financing costs this year would be cheaper if we gave them interest-free loans. But, ultimately, that still has to be paid back, and there would have to be some adjustment in the system—there would have to be higher taxes or something—to compensate for that. Money creation doesn’t change the ultimate amount of resources the government has to raise to pay for its spending.
The government’s right pocket could put numbers in the left pocket and not worry about ever being ‘paid back’. It could simply say that the numbers are a gift to the left pocket.
End of story.
The governor went on:
What gets people back into work is the fiscal spending. I agree with you that that is something we should be looking at—how much fiscal spending we have to get people back into work. I think where we disagree is on how that should be financed. I do not see monetary financing changing the total amount of resources that need to be raised by the government in the end …
Right pocket puts a big number into the left pocket then when people are getting jobs, one day, decides to make the number that it recorded against the left pocket, zero.
End of story.
A totally different scenario to issuing bonds to the private investment market, which have to be paid back with interest.
Later in the session, the Committee Chair (a conservative politician) disgraced himself with this statement:
Just quickly going back to what you called the ‘financial trickery of modern monetary theory’—and I very much welcomed the comments you made in your opening statement which clarified that rather than having to go through a long line of questioning …
The question that followed was about inflation (obviously), to which the RBA governor went further into the mire of lies:
Monetary financing of the budget deficit can lead to inflation, and that has all sorts of problems. It’s not guaranteed that we end up in the high-inflation situation for monetary financing, but it’s certainly possible …
Do we think it is okay for an economic system to run in a way where the government has its objective to use fiscal policy to keep things on a very even keel? I would say the history of that in the past has not been particularly good. Neither has the history of governments being able to stop doing this when inflation starts to rise. That’s why we ended up with the monetary arrangements we have …
The best way for government to meet its spending commitments is to borrow in the market rather than going to the central bank, and we can do that.
The reality is that the “monetary arrangements we have” were reflecting the ideological attack on active fiscal policy that accompanied the abandonment of full employment and the neoliberal surge.
Unemployment became a policy tool rather than a policy target.
We haven’t come close to full employment since the government imposed these restrictions on itself in the 1980s.
The monetary arrangements we have undermine prosperity and have allowed national income to be redistributed away from workers towards capital.
The RBA governors comments here just reinforce the neoliberal ideology.
Perhaps the Governor should explain this data
The Bank of Japan has been trying to produce an ‘inflation tax’ for year through its various quantitative easing and QQE programs.
They have not been successful, which is the same experience that the ECB has encountered with its huge public bond-buying programs.
First, the next graph shows the Total assets held by the Bank of Japan as a per cent of GDP (blue line) and the proportion held as Japanese Government Bonds between the March-quarter 2000 to the June-quarter 2020.
In the June-quarter 2020, total assets stood at 125.4 per cent of GDP (and JGB holdings were 98.8 per cent of GDP)
This particular statistic doesn’t matter one iota and just reflects the Bank of Japan’s large government bond purchasing program over the last 20 years.
The fact that buying JGBs in large volumes hasn’t caused any acceleration in the inflation rate demonstrates how ineffective monetary policy is in influencing the path of the inflation rate, despite the massive increase in central bank assets.
Now study the following graph, which shows the growth in the monetary base in Japan, driven mostly by the quantitative easing programs, and the inflation rate (both indexed at 100 in January 1990).
The Bank of Japan’s quantitative easing history began in earnest in March 2001 (QE1) and this increased the BOJs monetary base by around 66 per cent.
The Bank terminated that program in March 2006, whereupon the Bank sold down some of its holdings of JGBs (also shown in the graph).
A second (QE2) program began in October 2010 and as time has passed it has become QE3 and QQE, which is a much larger scale intervention that that began in April 2013 and continues at a pace today.
The monetary base increased by 36 per cent during QE2 and by, wait for it, 279 per cent in QE3/QQE to date. Not a small number.
You would expect if the mainstream macroeconomics predictions were robust then they should have materialised by now given these relative policy extremes.
The graph shows the evolution of these indexes up to July 2020.
At that date, the monetary base index was at 1429.6, while the CPI was at 101.7 (hardly shifted).
The overwhelming conclusion is that there is no relationship between the evolution of the monetary base (driven by the Bank’s purchases of JGBS in large volumes) and the evolution of the inflation rate.
One could argue that the reversal of QE1 revealed a lack of commitment by the BOJ to really drive the inflation rate up. My assessment is that QE doesn’t work whether it is extended for lengthy periods or not.
The reversal that followed the introduction of QE2 just reduced the monetary base (and the total assets held by the BOJ).
The RBA governor referred to ‘liquidity’ – saying that Australia was “flush with liquidity”. Tied to the rejection of any larger bond purchases, he was rehearsing the standard mainstream line that ‘too much liquidity’ would be inflationary.
But ask yourself what would drive an inflationary spiral.
The answer is that if bank lending increased dramatically and the broad money supply increased, which was a reflection of private spending growth, then that might trigger such a spiral.
By driving total nominal spending growth ahead of the capacity of the productive side of the economy to respond with increased production of goods and services.
The classic Quantity Theory of Money posits that if broad money growth rises, with stable turnover (velocity) of the money stock, then if the economy is at full employment then the only thing that will respond is the price level.
This is the classic Monetarist argument.
They also tie in central bank behaviour to the theory via the money multiplier, which posits that if the monetary base rises, then the broad money supply will increase by some multiple (that is determined by behavioural parameters).
The problems with this approach are many but for our purposes consider the following graph, which shows the growth of the monetary base since January 1995 and bank lending and the broad money supply measure, M2, also indexed to 100 at January 1995.
What do you see?
Nothing of interest in relation to the mainstream claim.
The point is that the massive increase in bank reserves during these QE and QQE episodes did not stimulate bank lending nor the broad money supply.
So while bank reserves have risen (increased ‘liquidity’) the broad money supply has not risen much at all (another measure of ‘liquidity’).
The RBA governor is thus in denial of this reality and is just rehearsing the tired mainstream arguments that haven’t ever been correct.
A sad intervention from the so-called ‘independent’ central bank.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.