Traders in the bond market are eagerly awaiting guidance from both the Reserve Bank (RBNZ) and Treasury on how monetary conditions will be tightened.
They’re interested in the mechanics of how the two arms of government will continue to work together to unwind the central bank’s bond-buying or Large-Scale Asset Purchase (LSAP) programme.
In other words, financial markets participants want to know how some of the money created via the LSAP programme will eventually be removed from the system to help put a lid on rising inflation and give the RBNZ headroom to potentially use quantitative easing again in the next crisis.
Treasury will give them a hint on Wednesday when it releases its Half Year Economic and Fiscal Update. It has confirmed to interest.co.nz it will provide some guidance on its future asset holdings (how much cash it wants to keep on hand).
Should Treasury say it wants to maintain a sizeable cash buffer to cover unexpected Covid-19 expenses for example, then its ability to buy the bonds back from the RBNZ could be limited… unless of course Treasury issues new debt to fund these purchases.
This is why investors will also be interested in the forecast debt issuance programme Treasury is due to publish on Wednesday.
But they will still be trading in a fairly uncertain environment. While Treasury will put some of its cards on the table, investors will have to wait until February for the RBNZ to say what it will do with its $53 billion portfolio of New Zealand Government Bonds, acquired via the LSAP programme.
Let’s go back a step
The RBNZ bought the bonds between March 2020 and July 2021 to lower interest rates to help boost inflation and employment, and support smooth market functioning at a time the bond market was being flooded with debt issued by governments who needed cash to pay for the Covid-19 response.
When the RBNZ launched its LSAP programme, it committed to buying up to $100 billion of New Zealand Government Bonds by June 2022.
However, because the economy rebounded more quickly than expected, the RBNZ stopped the purchases early, before it started lifting the Official Cash Rate (OCR) in October.
The RBNZ hopes increasing the cost of money using the OCR, ahead of turning its attention to how to reduce the supply of money, will cool an overheating economy.
Its preference is to prioritise using the OCR, as it’s a simpler and better-known tool than changing the supply of money by being an active player in the bond market.
As for the bonds it already owns, it can either let them drop off its balance sheet when they mature, possibly reinvesting some of those proceeds. Or, it can actively start selling the bonds.
While it isn't in a hurry to do so, it would be easier for the RBNZ to use bond-buying as a means of lowering interest rates again in the future, if it wasn't already such a dominant player in the bond market.
During the 2020/21 round of bond-buying, the RBNZ agreed it wouldn’t buy more than 60% of the New Zealand Government Bonds on issue.
The RBNZ being such an active player in the bond market has a material effect on the way the market functions.
The RBNZ and Finance Minister therefore agreed at the onset of the LSAP programme that should the RBNZ wish to sell its bonds, it would have to sell them straight to Treasury.
They figured it was better for Treasury and the RBNZ to be made to coordinate with each other than for the RBNZ to try to flog off bonds to investors at the same time Treasury issues new bonds. This could be confusing and distortionary.
Between March 2020 and July 2021, the RBNZ was made to buy government bonds on the secondary market, from banks that had bought them from Treasury, so as not to directly finance government spending.
But, should the RBNZ sell the bonds, it would need to work very closely with Treasury.
All eyes on Treasury for now
Again, the RBNZ will only provide guidance on how it will do this in February.
In the meantime, the commentary Treasury is expected to make on Wednesday, around how much cash it wants to keep on hand in its Crown Settlement Account with the RBNZ, might hint at how this bond portfolio will be managed.
As at October, Treasury had a whopping $37.5 billion in its cash account with the RBNZ. Two years ago, this Crown Settlement Account only had $4.9 billion in it.
Covid-19 has seen Treasury issue a lot of debt and run up this account on purpose to ensure it has cash on hand to cover unexpected expenses and promptly deploy economic support like the Wage Subsidy.
Financial markets will be hoping Treasury’s guidance is fairly detailed, by including a target range it would like the Crown Settlement Account balance to fall within over a set timeframe, for example.
Treasury will on Wednesday also update its forecast debt issuance programme, which will tie into all of this.
As at May, it forecast issuing $30 billion of New Zealand Government Bonds in the year to June 2022.
Because the strength of the economy is continuing to exceed expectations, one might expect this forecast issuance to be downgraded, unless the idea is for Treasury to issue additional debt so it can buy bonds from the RBNZ to clear the decks in preparation for the next crisis more quickly.
When interest.co.nz talked to Finance Minister Grant Robertson last week, he wasn’t keen to get ahead of the work underway by RBNZ and Treasury officials by sharing a view on the matter.
Central bank not so independent
Presumably the guidance will be principles-based and give both Treasury and the RBNZ enough room to move if circumstances change. Afterall, we’re far from out of this period of uncertainty.
Both Treasury and the RBNZ won't want their moves in the bond market to cause dysfunction or uncertainty. However, it will be interesting to see if their goals conflict in any way.
The RBNZ will be mindful of how any bond sales affect interest rates and thus its inflation and employment targets.
Treasury will be wary of ensuring New Zealand Government Bonds remain attractive to investors, and the Crown accounts are in good shape in accordance with the Public Finance Act.
While New Zealand is ahead of most other countries in unwinding stimulus, other central banks have previously been down the bond-buying path. So, we have experience to learn from. Two things are for certain:
1. It’s easier to increase the supply of money than it is to reduce it.
2. Public servants at number 1 and 2 The Terrace will continue to play critical roles shaping the market.
53 Comments
Reducing the supply of money in circulation is deflation by definition. The degree to which this helps alleviate consumer price rises depends entirely on how much of these rises can be attributed to an increase in the money supply ("inflation"), rather than increased cost of production.
I suspect the answer is "not much". If that is the case, what we might end up seeing is CPI heading back towards the target 2%, but goods and services becoming even less affordable as the dollar becomes more scarce.
It is money that has been borrowed, but is just sitting there. Some of it will be allocated, but not yet physically spent.
So Treasury borrowed the money by issuing bonds, which banks bought and then sold to the RBNZ. Now we are in a situation where Treasury might buy these bonds back off the RBNZ. This would tighten monetary conditions.
Good question. I don't know the answer. We are a few steps away from this situation. IE, the RBNZ will first have to decide whether it will sell the bonds. Then Treasury will say what it'll do with them. The RBNZ has time on its side, as the first big tranche of bonds don't mature until 2023.
This is monetarist nonsense that has not and is not reflected by the facts. For one, QE is an asset swap, the fruits of which only show up in the real economy as the result of lower long-term interest rates. That is, RBNZ only ever transacts in reserves, which by definition do not themselves enter the real economy. So, when RBNZ buys bonds from TSY or the secondary market, it does so with reserves. Moreover, like on so many matters of substance that he opined on, Uncle Milty was wrong on MV=PT. Just wrong. An increase in money supply means nothing if that money does not change hands. If I inherit $100 million from my dead aunt, that has no inflationary effect unless I spend it.
Re: fishers equation. M and V seem to have been moving in opposite directions like a stretched rubber band for over a decade. What happens if velocity picks up with that quantity of money in circulation? How do supply chains choking up factor in? Maybe nothing, Maybe that M is sitting on peoples balance sheets as equity in fine art, real estate etc.
"OCR, as it’s a simpler and better-known tool than changing the supply of money "
Which, of course, is getting the cart before the horse. It's not about 'the price of money' - never has been, but about the amount of Debt we have created. And beyond that - it's not about the amount of Debt, but what we've (all) used it for.
What a wonderful problem China has - it's built and made too much of everything. It's actually got something to show for its Debt. Whereas we've done what? Oh, yes. Made the price of everything we already had more expensive. And now we're all waiting for hints on what they want to do about it? (shakes head)
If it's her home, no one supports that more than me.
Just a shame that she might have had to pay twice what it could have cost her 5 years back; take twice as many years of her future work effort to pay off just one item in her 'things to do in life' list. But then again, I'm sure she was still finishing her NCEA 5 years back....
This will be a complicated exercise that has a potential to devastate the economy if mishandled. If increasing the interest rates causes the NZD to rise, our exports will turn relatively unattractive compared to other low cost producers in the world. This may dampen the positive effects of higher dairy prices farmers are enjoying right now. Coupled with a more attractive import scenario, it's not hard to imagine a further dive in the trade balances on NZ books.
The effect of raising the cost of money may also be felt by the government's current debt but also businesses in which they become dis-incentivsed to invest in expansion and that has a flow on effect on employment and the velocity of wages.
As cost of debt increases, I'm expecting less public spending on infrastructure building and social welfare.
To the dismay of first home buyers, the rising interest rate would also mean that marginal buyers will be permanently locked out of the market and for those who qualifies, their expectations will need to be drastically reduced to meet their loan hurdle.
Going forward, it will be a good for rents and motel owners- the good same old days.
CWBW,
"If increasing the interest rates causes the NZD to rise, our exports will turn relatively unattractive compared to other low cost"
Clearly you don't want to let any facts get in the way of your theory. We have already started to raise the OCR while the US has not, yet the NZ$ has fallen over the last month from 0.70 to 0.67. Any comments? Moves in our $ are influenced by many factors most of which are external.
Your view on infrastructure and social welfare doesn't wash either.
This all gets a bit easier to understand if you look at what is happening operationally:
- Govt has a special current account at RBNZ called the Crown Settlement Account - the balance is currently $37.5bn
- Commercial banks have special current accounts at the RBNZ called settlement accounts (total combined balance $36.6bn)
- You can see the total credit in these accounts under 'Memorandum Items' on the R3 balance sheet on the RBNZ website.
- These settlement accounts are very special - they effectively form a closed system. Money in these accounts can only move to other settlement accounts in this closed system. A commercial bank never 'lends money out' to customers from these accounts (or deposits any customer money in them).
- When Government spends some money (e.g. $100m on pfizer vaccines) they effectively credit the settlement account of pfizer's commercial bank with $100m and debit the Crown settlement account by the same amount. The commercial bank then credits Pfizer's account with $100m (creating a $100m liability on its balance sheet). Note that the commercial bank settlement account is still up $100m - the money doesn't 'move' (the asset in the settlement account just balances out the new liability).
- When Govt sells $100m of bonds, they debit $100m back out of the settlement account and credit the Crown Settlement Account with the same amount.
- In usual times, Govt aims to keep around $5bn in its crown settlement account and commercial bank settlement accounts usually have a combined balance of around $8bn. These balances are enough to settle payments between commercial banks and between those banks and Govt (in that closed system). Treasury has the job of keeping balances about right by buying and selling bonds. Banks can also lend money to each other between settlement accounts to ensure that payments between them are covered
- When RBNZ bought $58 billion of bonds they credited commercial bank settlement accounts with new cash - this inflated commercial bank settlement accounts.
- This put the whole system out of kilter - an extra $58bn of money went into commercial bank settlement accounts on top of increased Govt spending, and with tax revenue unexpectedly high, Treasury did not need to sell any bonds to keep the Crown Settlement Account at the desired level. This meant that commercial bank settlement accounts and the Crown settlement account have been bloated way above usual levels - by a combined amount of $60bn (about the same as the LSAP bond purchases obviously)
- Backing out of this arrangement involves a three-way deal between RBNZ, Treasury and commercial banks. Treasury will have to sell bonds to commercial banks thus reducing commercial bank settlement deposits by around $30bn (back to usual levels). This will increase the crown settlement account by $30bn to a staggering $67.5bn. Then, Treasury will have to buy the bonds from RBNZ for around $60bn - reducing the Crown Settlement Account back to more normal levels. RBNZ balance sheet would then be back to usual too. This will presumably be done gradually.
- Note that the operation above should make very minimal difference to the Govt balance sheet debt will not go up or down.
- Note that the balances in commercial bank settlement accounts are part of Govt debt. So, when Govt sells bonds to commercial banks (or buys them back using QE / LSAP) govt debt levels do not change.
- Govt does not therefore 'borrow money from the private sector' when it sells bonds, it is just exchanging bonds for the money it has spent but not taxed back yet.
Thanks for your detailed explanation Jfoe, you seem to know what you're talking about and I will gladly admit I don't fully understand it. I have a question, in point 8 you say:
8. When RBNZ bought $58 billion of bonds they credited commercial bank settlement accounts with new cash - this inflated commercial bank settlement accounts.
Am I correct to assume the increased cash in the commercial bank's settlement account has not made it to consumers in the form of new loans, i.e. the additional $58 billion has not been injected (or lent) into the real economy?
Thanks
New loans are made. The 'cash' may not move, but the liability; a bank balance sheet item, does.
"The commercial bank then credits Pfizer's account with $100m (creating a $100m liability on its balance sheet). Note that the commercial bank settlement account is still up $100m - the money doesn't 'move' (the asset in the settlement account just balances out the new liability)."
So in layman's terms the $58 billion of bonds printed have made it out to the real economy. It may not be in cash but it is $58 billion in additional lending, by commercial banks, borrowed by Joe Bloggs looking for something to buy.
Is that understanding correct?
bw ?
Jfoe ?
Audaxes ? (keep it simple please)
Jenée ?
Thanks to all
Let's put it this way. What would you do, as a bank treasurer, if you had $X sitting in an account somewhere that you could create a counter image of, lending to the commercial sector at interest? Ignore it?!
Banks employ the smartest of the smart; way above what the regulators are, and I can tell you from observation and practice, what's supposed to happen, and what actually does can be vastly different.
It depends. RBNZ bought bonds on the 'secondary market' - i.e. from financial institutions that do not have settlement accounts at RBNZ. When they do this, the commercial bank with the settlement deposit account acts as an intermediary and the bond seller (usually a pension fund or investment company) does end up with actual cash to spend (and a very tidy profit). So, where do they put this cash? Well, obviously they don't lend it out - they either buy more bonds or invest in relatively safe corporate shares. This is why share prices went crazy during Covid programme - the price of shares was pushed up by investors who were cashed up after selling bonds to RBNZ.
Bank of England explains it reasonably clearly here... Note that anybody that understands QE knows that the main impact is boosting the price of financial assets and (therefore) helping to hold interest rates / borrowing costs down.
Thanks bw & Jfoe, unfortunately not a clearcut answer and one that Legit above disagrees with.
by Legit | 13th Dec 21, 7:12pm
This is monetarist nonsense that has not and is not reflected by the facts. For one, QE is an asset swap, the fruits of which only show up in the real economy as the result of lower long-term interest rates. That is, RBNZ only ever transacts in reserves, which by definition do not themselves enter the real economy.
I have searched for a simple straightforwards question for some time now and I have heard conflicting opinions but never a straightforward, simple answer. My question is:
Does QE provide more funds, if not in cash, in lending/borrowing to the real economy? (or is QE only lowering interest rates)
Can anyone answer this question with a simple yes or no without going into the mechanics of what QE is supposed to achieve please?
No, I think Jfoe is right about RBNZ secondary market bond purchases, but that still involves RBNZ putting reserves in the intermediary commercial bank’s settlement account with RBNZ, and the commercial bank marking up the bond seller’s account with the commercial bank. I only skimmed bw’s comments, but they seemed on target too.
My take on your questions are:
1) Not directly, because central banks do reserve accounting/ transactions, and don’t transact in the real economy. However, as BoE acknowledges in Jfoe’s link, lowering interest rates from QE tends to increase borrowing from banks to buy assets as investors look for better returns - which pumps up asset prices and bubbles.
2) Not if you want a useful answer.
Yes, that's my understanding too. If RBNZ buy $20m worth of bonds on the secondary market, they credit the commercial bank's settlement account with $20m, and that bank then credits the bond seller's bank account with $20m, which the bond seller can then spend. However, the bank's settlement account stays at +$20m (balancing out the bank's liability it created when it credited the bond seller's bank account).
If you want to twist your head some more - think about what happens when the newly cashed up bond seller decides to buy a $20m yacht owned domestically. They instruct their bank to credit the yacht seller's account at a different bank with $20m. The bond seller's bank account goes down -$20m, their bank then tells RBNZ to debit $20m from their settlement account at RBNZ and credit $20m to the settlement account of the yacht seller's bank. The yacht seller's bank then credits the yacht seller's account with $20m. Note that the total balance in settlement accounts does not change. It is a closed system - the balance on settlement accounts only changes when taxes are paid to Govt, Govt bonds / securities are bought or sold, or Government spends (or when banks buy real printed money from RBNZ but that is tiny).
It depends upon whether the central bank is buying up only governments bonds or other assets as well. This video gives some explanation.
https://www.rbnz.govt.nz/research-and-publications/videos/money-creatio…
"Govt does not therefore 'borrow money from the private sector' when it sells bonds, it is just exchanging bonds for the money it has spent but not taxed back yet."
And all the above just illustrates one thing - The Government doesn't need to 'tax back' anyone to rebalance the accounts. Tax is irrelevant.
The accounting scheme above shows us why.
What appears 'bloated' today will become just a yawn tomorrow, and bloated will be reclassified in the trillions of dollars.
And none of it will require - taxation.
From the RBA - Box D page 75-77 (79-81 of 104) PDF Monetary Policy Statement
The increase in banks’ holdings of government debt has created deposits The purchase of government bonds by the banking sector can add to deposits in a similar way to the extension of credit to businesses and households.[2] Banks have purchased some of the newly issued state government debt. In the first instance, those borrowed funds are held by the state governments as a deposit with a commercial bank until the funds are spent.[3] In addition, when the banking sector purchases state government debt in the secondary market from the private (non-bank) sector, it credits the deposit account of the seller to pay for the transaction. In both cases, new deposits are created. Deposits have risen in recent months, as banks’ holdings of state government debt have increased and as state governments have issued debt (Graph D.3). Banks’ holdings of Australian Government Securities have also risen recently, alongside an increase in Australian Government borrowing, which has contributed to the rise in bank deposits. However, the process of deposit creation is slightly different when the banking sector purchases debt issued by the Australian Government, since the Reserve Bank is the banker for the Commonwealth of Australia. When the Australian Government borrows from the banking sector, it holds the borrowed funds as a deposit at the Reserve Bank until the funds are spent. As the Australian Government spends these funds in the economy, such as in the form of Job Keeper payments to businesses, it adds to deposits held by businesses and, subsequently, to deposits of the household sector through employees of those businesses.
When the Australian Government borrows from the banking sector, it holds the borrowed funds as a deposit at the Reserve Bank until the funds are spent.
Exactly: Banks don't take deposits and they never lend money. They are in the business of purchasing securities. When one gets a bank loan, the loan contract is a promissory note. The bank purchases that contract from the borrower. Now the bank owes the borrower money and it creates a record of the money it owes, which we call deposits - source.
Detailed and helpful picture, thanks Jfoe. A post script I'd add to 10) is that TSY will not - never - struggle to sell their bonds to the banks, because unlike reserves (from RBNZ bond buying), TSY bonds pay interest. The choice the banks face is therefore a no-brainer: they get some return by buying TSY's government bonds; or they get no return by holding the reserves. This is also why bond vigilantes are not a thing. The banks always buy the bonds. #Japan
Yes, although, as Audaxes notes, is not that clear cut. Firstly, RBNZ are paying OCR on all balances, which is not too bad. Secondly, banks will choose to hold back from bidding too high if they think yields are going to increase in the future (i.e. they will get a better deal at the next auction). The banks will basically continually test the central bank's appetite to intervene - whilst assessing how easily they will be able to on-sell the bonds for a profit in the secondary market.
How Treasury and the Reserve Bank could work together to remove billions of dollars from the financial system
Impossible. Simply:
A recent Bloomberg article described central bank easing with the phrase “pumping money into the economy.” That’s a misconception. Monetary easing is actually an asset swap. The public was holding savings in one form, and now it holds it in another. The Fed buys Treasury securities from the public, and replaces them with currency and bank reserves (base money) that someone has to hold, at every point in time, until the Fed sells its bonds and retires the cash. All monetary policy does is to change the mix of government obligations held by the public. Only fiscal policy – specifically deficit spending – changes the total amount of those obligations. - courtesy of Hussman
As part of the package of monetary policy measures announced in mid March, the Reserve Bank began to purchase government debt from the private sector, to support the three-year yield target and address market dysfunction. Around $50 billion of government bonds were bought from March to early May, and around $1 billion in early August. These bonds were purchased by the Reserve Bank from a panel of commercial banks via auction, and were paid for with newly created money credited into banks' Exchange Settlement Accounts (these balances do not count as deposits, as they are not held with the private banking sector). Some of these bonds sold by commercial banks would have been purchased from non-bank investors, generating a flow of funds into non-bank investors' deposit accounts.[5] Box D: Recent Growth in the Money Supply and Deposits
My formal economics education was supplied by Mr Micawber in the Charles Dicken's novel David Copperfield.
Mr Micawber proclaimed the following fundamental principle to be the ultimate guide in all things financial:-
Annual income 20 pounds; annual expenditure 19 pounds, 19 shillings, and sixpence: the result happiness.
Annual income 20 pounds; annual expenditure 20 pounds, and sixpence: the result misery.
I guess only mugs follow this advice today, although FHBs do have to follow this advice when saving for a deposit to buy their first home. But it worked for me in the late 1950s and 1960s.
I suppose if the financial sleight of hand described in this article works then time-travel is possible afterall.
This is because now people who are running the country to suit the vested biased interest are forcing by their policies towards debt than saving.
Who is to be blamed...you decide.
Mr Orr and Robertson who says that new Mantra is :
Annual income 20 pounds; annual expenditure 19 pounds, 19 shillings, and sixpence: the result MISERY
Annual income 20 pounds; annual expenditure 20 pounds, and sixpence: the result HAPPINESS
AND
Annual income 20 pounds; annual expenditure 24 pounds : the result PROSPERITY.
IMO you are both confusing cashflow with financial position. It still holds true today that positive cashflow is good and negative cashflow is bad. What is different is the attitude towards debt to buy an income producing asset. In the olden days debt was considered bad, today debt is great, Unfortunately few have caught onto this
Would several of the bigger brains on this here thread like to have a go at answering Michael Reddell's oft-repeated note:
Using mark to market, LSAP total holding is valued at several billions less now than when them 'assets' were purchased.
Is that loss a real one in the sense that real munny (taxes, lost opportunities like more ICU's etc) is needed to make it good, or is it just more financial wanglery?
Inquiring but simple minds would like to know....and the less polysyllables the better.
Agree with Audaxes. My only side note is that Michael is cherry-picking the data to make a political point. Govt owned financial assets increased in value by $52 billion between 2020 and 2021 - and LSAP was a contributory factor to this increase. If an investor lost $5bn on one play, but this helped them make $50bn on another, everyone would say they were a genius. My view is that over the course of a couple of years, the LSAP programme will have a net positive impact on the Govt's books.
What a lot of mainstream nonsense this article is. For anyone interested in learning how our governments finances really work in reality then they can do no better that read this item by economist L.Randall Wray.
Understanding Modern Money: How a sovereign currency worksi
https://www.levyinstitute.org/pubs/Wray_Understanding_Modern.pdf
Tread, I think you'd enjoy this from Dr Hail if you haven't already read it: http://www.global-isp.org/wp-content/uploads/PN-121.pdf
Btw - Tread, Jfoe: are you based in Wellington?
Great article Jenee, did it feel ridiculous writing the following? 'Between March 2020 and July 2021, the RBNZ was made to buy government bonds on the secondary market, from banks that had bought them from Treasury, so as not to directly finance government spending'. Sure seems ridiculous reading that, not directly financing the government... Yeah right.
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