April 11, 2020

Why Australia is printing money

It is and that may concern many Australians.  But the UK and the USA have been doing it on a large scale for years with no obvious ill effects.

It goes back to a recommendation by John Maynard Keynes that the government should spend more money than it takes in during a recession or depression.  And that is exactly the situation today.  We are in a situation where a Keysnesian stimulus is appropriate.  When people are not spending because they have lost their jobs, it would normally send lots of businesses broke.  Businesses need people to keep spending. So it makes sense for the government to do their spending for them.

Usually, of course, the government would spend on their own projects but this time governments are actually putting a lot of the new money directly into the pockets of those who have lost their normal income.  But either way the government can and should spend up big on keeping people and businesses afloat.

Unfortunately, governments really like spending money without first taking it in and Keynes has legitimated that.  Keynes said to print money in a recession but government have ignored that restriction and printed some money regularly. So there is usually a small amount of money printing going on.  That is why prices are usually rising.  The extra money leads to extra demand for goods and services and that pushes prices up -- which we refer to as "inflation".

The interesting question, these days is how much you can get away with printing without causing inflation to "roar". Economists always thought that inflation would roughly mirror the amount of new money printed. But in recent years we have seen that you can print a large amount of money and get only a small amount of inflation.  First Obama and now Trump have used that extensively in that they have spent far more than the government has raised in taxes. We have yet to see where that will end up


Hundreds of billions has been spent to help the economy and interest rates have tumbled. But the central bank has also splashed on another plan

The Federal Government has splashed more than $200 billion in support packages to keep the economy ticking over as the coronavirus halts trading for nearly all industries.

The central bank has chipped in, too, recently slashing interest rates to a record level of 0.25 per cent at an emergency meeting.

It has also injected a huge amount of cash into the economy by purchasing $36 billion worth of government bonds since March 19 “to do what is necessary” to help ease the burden on the suddenly surging jobless Australians.

“The Bank has injected substantial liquidity into the financial system through its daily open market operations to support credit and maintain low funding costs in the economy,” the Reserve Bank of Australia governor Philip Lowe said in his statement this week.

“It will continue to ensure that the financial system has sufficient liquidity.”

The central bank will continue to buy government bonds but this will be pulled back and done on a smaller scale in the near term.

But what does this all mean?

Also known as quantitative easing, an avenue to inject money into the economy is by creating extra cash and using that to buy government bonds or other financial assets, AMP Capital chief economist Shane Oliver said.

“They could buy mortgages or corporate debt, which is what the Federal Reserve does in the US, or they could buy shares, which is what the Bank of Japan sometimes does,” he told news.com.au.

The process of buying and selling bonds is part of the RBA’s standard monetary operations to maintain liquidity in the financial system, though this is isn’t usually done through printing money.

SO THE RBA IS PRINTING MONEY?  Essentially, yes, says Dr Oliver.

“For all intents and purposes, they physically print it because they engage in a transaction with a bond holder — which could be a bank, it could be a fund manager, or it could be a foreign organisation,” he said.

“They're going into what you call secondary market for Australian government bonds, when a bond has already been issued by the government and someone has already bought it.

“That bond holder can then sell it on or trade it. So the reserve bank goes into these secondary markets, buys those bonds and in the process transfers money into the account of the person selling the bond. “And to do that, they obviously have the cash backing that.”

The money used to purchase the bonds is electronic but the central bank would have needed to back that up by creating more cash. “Money doesn't just get created in thin air, the Reserve Bank would use printed money to buy that,” Dr Oliver said.

“The RBA is actually increasing the size of its balance sheet and the asset it gets is a government bond. But the liability is, in principle, cash.”

BUYING BONDS IS A GOOD THING

The process has become a popular economic policy move across the globe in the recent months as the coronavirus cripples supply chains and halts business. The United Kingdom and the US have embarked on similar schemes.

“The problem facing Australia right now is a supply shock with people stuck at home and can't work in some cases,” Dr Oliver said.

“But there's also a demand shock so anything the Reserve Bank can do to make it easier for the government to borrow money to finance things like wage subsidies, higher unemployment benefits and payments to companies to help them through this period is a good thing.”

WILL AUSTRALIA SUFFER LATER ON?

Like any of the stimulus packages being hurled at the frontline of the economic crisis caused by the deadly pandemic, it is increasing the nation’s debt.

“It will come at a cost but providing it's managed well and the Reserve Bank, when the time comes, puts an end to money printing before inflation becomes an issue, then I don't think it's a major problem,” the leading economist said.

“It’s similar to federal government borrowing money to pay wage subsidy and other supportive measures through this period in that it will come at a cost down the track if it’s not withdrawn. “The trick is that once the need is over, then it’s brought to an end.”

SOURCE 






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