The Treasury expects the Reserve Bank’s (RBNZ) quantitative easing, or Large-Scale Asset Purchase (LSAP) programme, to directly cost $5.1 billion.
When the programme, designed to lower interest rates and soothe dysfunction in the bond market, was launched in early-2020, the Treasury expected it to be cost-neutral over time.
But now that interest rates are rising more quickly than expected, it estimates the net direct fiscal cost will come in at $5.1 billion.
The Treasury unveiled this figure in its 2022 Investment Statement, noting the cost of the programme will only be known once it is completely unwound by 2027.
Background
The LSAP programme saw the RBNZ create money to buy $53.5 billion of New Zealand Government Bonds (debt) on the secondary market between March 2020 and July 2021.
The idea was that by the RBNZ becoming a very active bond-buyer, the price of government bonds would go up. This would lower government bond yields, which would feed through to lower interest rates across the rest of the economy.
The RBNZ wanted to slash interest rates to stimulate the economy and keep inflation and employment buoyed. It launched the LSAP programme, because it didn’t have too much scope to keep cutting the Official Cash Rate (OCR), which was already nearing zero.
This suited the Treasury, because it kept interest costs low on the debt it was issuing to cover Covid-related expenses.
Details
Because interest rates were tracking down in 2020 and early-2021, the government bonds issued earlier in the period were higher-yielding. This made them more valuable.
So, when the RBNZ went about buying the bonds on the secondary market (IE from banks that bought them from the Treasury), it paid a premium. The eligible banks included ANZ, BNZ, Citibank, ASB's parent Commonwealth Bank of Australia, Deutsche Bank, HSBC, JP Morgan, Morgan Stanley, Rabobank, the Toronto Dominion Bank, UBS and Westpac.
The Treasury said the RBNZ paid $7.2 billion more for the bonds than what they were originally issued for. This was recorded as a loss on the government’s balance sheet and resulted in an increase in net debt.
Initially, the Treasury wasn't too concerned about this, arguing the loss would be offset by the LSAP programme lowering interest costs on government borrowing.
Fast-forward less than a year, interest rates are rising more than expected, as the economy is overheating and Russia's invasion of Ukraine is exacerbating inflationary pressures.
The benefits of the LSAP programme aren’t lingering for long enough to offset the upfront cost. Or in the Treasury’s words, “The loss on the government balance sheet and reduction in debt servicing costs are no longer expected to offset each other.
“Based on current interest rate expectations, the net direct fiscal cost from the LSAP programme is currently expected to be $5.1 billion…
“This is calculated as the fair value of the government indemnity to the RBNZ, valued at $5.5 billion in January 2022, less cumulative interest savings to date of $0.4 billion.”
Importantly, the Treasury noted we won’t know the ultimate loss or gain from the LSAP programme until it is unwound in 2027, when the RBNZ is due to have sold the last of its NZ Government Bonds back to the Treasury. The RBNZ is due to start selling the bonds in July.
Change in interest rate risk profile
The Treasury made another point. It noted the LSAP programme has made the government’s balance sheet more sensitive to changes in the OCR (which is expected to rise steadily).
This is because the RBNZ is paying banks interest (at the OCR) on the cash they received from the RBNZ when they sold it their government bonds in 2020 and 2021.
As at March 18, the RBNZ was paying interest on $49.1 billion of deposits banks had in their settlement accounts with the RBNZ. In February 2020, the balances of these accounts sat at only $7.4 billion.
Was the LSAP worth it?
The lowering of interest rates undoubtedly boosted asset prices and supported demand, employment and government tax revenue.
However, it’s difficult to untangle the impact of the LSAP programme from the impact of the other tools the RBNZ used to lower interest rates - the OCR and Funding for Lending Programme.
The Treasury noted the RBNZ in August 2020 estimated NZ Government Bond yields were at least 50 (and potentially more than 100) basis points lower thanks to the LSAP programme.
The Treasury also said the LSAP programme is “expected to have increased tax revenue by supporting broader economic output”.
Former RBNZ manager turned blogger, Michael Reddell, saw the Treasury’s lack of analysis of the benefits of the LSAP programme as an inditement on the RBNZ.
By lowering longer-term interest rates, he said the LSAP programme was designed to benefit the government more than households and businesses, which tend to borrow money on shorter-term rates derived from the OCR.
But still, the Treasury expects the government to suffer a $5.1 billion loss on the programme.
“The bank took a punt, and the punt hasn’t paid off,” Reddell said.
Indeed, the Treasury said, "In establishing the LSAP programme it was understood that uncertainty over the future path of the OCR meant that the programme could result in a material gain or loss."
Reddell recognised that back in March 2020, no one expected the economy to bounce back so quickly. However, he believed the RBNZ could’ve stopped buying bonds sooner than it did, once a recovery was visible.
Post-match review needed
Reddell was also critical of the RBNZ not publishing a proper risk assessment of the LSAP programme, detailing what would happen if interest rates rose.
Infometrics principal economist Brad Olsen likewise noted the lack of scrutiny of the LSAP programme when it was launched in a rush, as bond markets were gumming up and the economic outlook was disastrous.
He said a post-match review was particularly important, as the RBNZ has kept the door open to using bond-buying again in the future.
One of the reasons the RBNZ has given for it deciding to actively sell the bonds it bought, rather than let them drop off its balance sheet as they mature, is that this would clear the decks and make it easier to potentially use bond-buying again in the future.
Nonetheless, the Bank itself has expressed some hesitancy around using the tool to set monetary policy.
It has said the better-understood OCR would be the primary tool it would use to tighten monetary conditions going forward. It didn’t expect the gradual selling down of its bond holdings to have too much of an effect on interest rates, although the jury is still out on this.
Labour MPs on Parliament’s Finance and Expenditure Committee have blocked numerous requests by Green MP Chlöe Swarbrick for a review to be done of the government and RBNZ's economic response to Covid-19.
Swarbrick's concerns largely relate to the distributional impacts of low interest rates - IE the way they've benefited asset owners.
Meanwhile National MP Andrew Bayly has raised concerns in committee meetings about losses related to the LSAP programme.
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"Labour MPs on Parliament’s Finance and Expenditure Committee have blocked numerous requests by Green MP Chlöe Swarbrick for a review to be done on the economic response to Covid-19."
Chlöe isn't the most financially literate of all the MPs, but she has definitely seen the unintended consequences of RBNZ idiocy. Pity the government is intent on sweeping it all under the carpet.
I reckon she knows enough to be dangerous (to sitting parties), but probably wouldn't be a good finance minister (Arts/Philosophy major). Though in saying that, she would be much more aware of the limits to growth and not educated to believe the obviously wrong economic doctrine that most economists have been stuck in for the last couple of decades, so may just be the person for the job.
Given this is going to cost $5 billion or around $1000 per person, and in general the proceeds went to banks, and indirectly to property owners. Can we compare outcomes to if they had just given everyone $1000 of helicopter money at the start of the pandemic? It would certainly have been more equitable.
Yep, it's what I said to Grant Robertson in a submission to him when they announced all the crazy measures. I told him his de-risking of the property market was a crazy decision, especially given the support thrown at it by the RBNZ and that it would backfire on his goal of reducing inequality. That the better path would have been helicopter money as it went to everyone, along with the wage support. Never did get a response back, can I write to him now and said "Told ya so!"?
It (RBNZ) didn’t expect the gradual selling down of its bond holdings to have too much of an effect on interest rates, although the jury is still out on this.
They are being extinguished by Treasury purchases, not sold to the public.
Importantly, the Treasury noted we won’t know the ultimate loss or gain from the LSAP programme until it is unwound in 2027, when the RBNZ is due to have sold the last of its NZ Government Bonds back to the Treasury. The RBNZ is due to start selling the bonds in July.
The volume and tenor of new debt issuance will be significant determining factors of term interest rates, while Treasury executes staggered off-market purchases out to 2027.
As I have noted before:
"Investors" have persistently over capitalised the rising discounted present value of cash flows associated with assets, financed by bank credit as interest rates fell.
Policy makers sometimes flatter themselves with the idea that holding interest rates at untenably low levels makes it cheaper for borrowers to obtain funds. Unfortunately, it does so only by transferring income from people who are trying to save for the future. Replacing Treasury securities with base money may make savings more “liquid,” but it doesn’t suddenly make people abandon their retirement plans in favor of consuming today. Low rates also don’t magically create productive investment opportunities.
What economic activities suddenly become viable at zero interest rates that were somehow not viable before? Only projects so unproductive that any positive hurdle rate would sink them. The main activities that are encouraged by zero interest rates are activities where interest is the primary cost of doing business: leveraged real estate transactions; “carry trades” that employ enormous amounts of leverage to profit from small yield differences; and speculation on margin. Presently, margin debt as a percentage of GDP is at a historic extreme.
https://www.hussmanfunds.com/comment/mc210614/
Indeed. What I would give for everyone on here to take a 101 course in how the settlement account system works with the wider banking system, and, what happens operationally when bonds are bought and sold on the primary / secondary markets, and when Govt spends and taxes. Maybe you should offer classes Audaxes?
This is what happens when you have a prime minister and a finance minister who place "well being" above a balanced fiscal spending.
Even Helen Clark would cringe at how "left" this labour govt has become. Jacinda's fake tears won't be fake when her and her communist cronies get kicked out of office in 20months time
It pales in comparison to the $1000 billion gifted to the wealthy (mainly property owners) since the start of COVID.
Thank you Jenee for reporting this. The 5 billion would be borrowed again, the classic debt perpetual cycle. The western world has perfected the art of getting your kids to pay for your own extravagances. Poor kids did not install this government or RBNZ governor into power, yet they’ll probably end up paying. Disgusting if you ask me.
I think the whole LSAP thing was daft - other central banks realised that they could hold interest rates down by simply threatening to do QE. And, as I have said many times before, a smart central bank would have focused more on controlling the quality of credit - i.e. who gets to borrow at what rate for what.
However, it is worth remembering that the total value of Government's financial assets (shares, investments, derivatives etc) - including paper losses from LSAP - increased by well over $50bn during this period. I don't think anyone should be writing articles praising Govt's most excellent investment strategies - but it is only fair to report on the whole balance sheet rather than a couple of the lines on it. If someone only looked at my credit card bill at the end of the month, they would think I was broke and stupid (the latter may be true)
For those who don't understand QE and are wondering who ends up benefiting on the counter party side. The banks and those who were able to trade debts for cash, the banks, and other bond buyers. I.e. NZ tax payers end up giving billions of dollars to banks in order to be able to borrow from them at low interest rates, when rates were already at record lows. As a result taking out massive mortgages as a result, limited increase in consumer spending (because the problem was always supply side, not demand side during COVID)....
What's most worrying is, as someone in finance, managing capital, providing commentary on economics to boards, that most economics say they wouldn't change a thing that the central bank did. Are these economists even using their brains, are these the same economists advising the government. Blows my mind that government is taking these peoples advice on board to make decisions that will impact generations to come. I know we are in relatively unchartered territory with QE and bond yields at negative YTM's, but come on guys, surely the basics don't go out the window and we just default to print money it'll be fine?
SomeGuy
Great comment.
With the benefit of hindsight, now might be a good time to reflect on whether the beneficiaries of the LSAP program just happened to be in the right place at the right time, and the losers just unlucky, or whether this massive transfer of intergenerational wealth might just have been intentional.
Those that understand QE know that NZ tax payers are not 'giving billions of dollars to banks' when they undertake QE - they are swapping Govt debt in the form of bonds for Govt debt in the form of settlement account balances - no increase in Govt debt at all. And banks can NOT lend money out that is sat in their settlement accounts balances at RBNZ, which is why they currently have $40bn sat there miserably earning OCR.
The hedge funds and other investors that sell Govt bonds (debt) to RBNZ on the secondary market, do receive cash in their bank accounts, which they almost certainly used to buy other safe financial assets (boosting share index prices for eg). Govt bonds are so liquid that they are a whisker away from being 'cash' anyway meaning the impact of QE / LSAP is massively over-stated. As I have said many times, RBNZ could have held interest rates by simply stating that they would take any action necessary to do so.
Australian owned banks have been & will continue to be the main beneficiary of this $5 billion loss in NZ taxpayer funds or approximately $1,000 per person.
Heads should roll for such a destruction of NZ taxpayer funds.
I bet the Australian banks love this this government.
It is a shame that the $5 billion wasn’t directed towards our renters & poorest members of NZ society.
The direct and indirect impacts of Covid-19 Government mismanagement begins to surface.
I'd say we are living a D - Grade Mexican Horror movie, compliments of the bureaucracy.
Most illusionary, almost dystopian, is that a meaningful percentage of New Zealanders still support these muppets.
Will someone or something please save us from this torture before New Zealand is an economic basket case???
The problem is lack of alternative. National would have done the same. NZ politics has devolved into the same style of two-party system as the US, which is really just one party being branded in two different ways, to give the illusion of choice.
Today, the main role of government in Western capitalist democracies is wealth protection. Government is no longer the dominant institution in such societies, capital is. Voting won't change this.
Would National have done the same with the massive blowout in Covid-but-not-really-Covid related spending? I strongly suspect that the maturing Social Investment approach would have seen more money ended up in the hands of people who needed it than hand-picked tourism operators in Queenstown.
Bernard Hickey wrote an excellent open access piece on the impact of QE and where the money went. To paraphrase him (pse correct me if I misconstrue anything).
The $50b+ was expected to free up cash and allow reinvestment in business-new equipment, expansion etc. In reality it led to depressed and artificially low interest rates and a boom in residential house purchases (and sig price increases). The wealth created clearly favoured those with houses/equities etc and worsened inequity.
So in addition to the damage done, there is now another loss of $5B? You couldn't make this stuff up in a cheap novel. The media should be all over this.
What catastrophic incompetence!!! If a business was run half as badly, it would go bankrupt right away and its employees lose their jobs. The use of technical words to explain the immense mistakes and shortcomings is sickening. Allow me to put it in more simple terms, the decisions by the Government and the RB have been terribly bad, totally incompetent and they are costing Kiwis a lot of money. They deserve to lose their jobs and be replaced
How come you weren't saying this Yvil while they were pushing interest rates to zero over the last 10 years while property prices were exploding? Because this has always been the probable outcome when the cycle reverses....pushing interest rates to zero is simply pain avoidance and stupidity....and pain avoidance is a policy used by weak characters (not saying that is you personally, just saying that the concept of avoiding pain like central banks have, and that this has been acceptable by society, is a sign of weak policies and weak society).
The LSAP is a purely accounting issue for Treasury and RBNZ. Treasury sold bonds cheaply, the RBNZ bought them expensively. So Treasury will now buy them back at a lower price than they sold them, thus booking a profit. That profit will be transferred to RBNZ via an "accounting entry" to cover the indemnity it gave RBNZ against losses. Treasury profit = RBNZ losses.
Treasury has $30 billion + sitting on deposit with RBNZ having overfunded in the last couple of years. So that's where the money to buy back the bonds will come from.
To get Treasury back to where it started - replacing that $30 billion - they will have to issue new bonds. Of course, the new issues will be at today's much higher rates. But that will simply be an opportunity cost, and opportunity costs are not a budget item.
So the whole thing will be done "in house". There will be no "$5 billion loss" at the government-to-government level.
Perhaps not entirely an internal accounting issue. The RBNZ bought the bonds in the market, not directly from the Treasury.
When I raised the question near the top of this thread as to who the beneficiaries were on the other side of the deal I was not implying that there is a simple answer. And I was intrigued to see whether or not the responses would span both accounting and real economic costs.
Also, there are other beneficiaries and losers from the LSAP outside the narrow accounting perspective.
KeithW
I don’t think it makes any difference the RBNZ bought the bonds from the banks or Treasury directly. In very broad terms, Treasury sold $50 billion of bonds to RBNZ via the banks (minor ticket clipping on the way thru) and those bonds are now worth $45 billion due to a big jump in rates. Treasury buys $50 billion of bonds back for $45 billion booking a $5 billion profit. RBNZ book a $5 billion loss....
What's another $5bil between NZer's hey...?
Oh that's right,
- record house price inflation 30-40% jump
- highest fuel prices in 20 years
- food inflation...
- and coming interest rates increases to correct their own mistakes....
Thanks Labour + Orr.... (by thanks I mean no thanks...) but by all means continue your 'borrow, tax and spend' policies....
The media should be all over them like a bad rash (granted, easier said than done), but they have been well trained to behave.... by asking no tough questions or holding them accountable...or
Risk get issued a naughty card and be excluded from any future press conferences
Sounds very... well... 'undemocratic'... let's say...
$5bn. Say it quickly and it doesn't sound a lot. Indeed, in say the context of light rail, it wouldn't come close to meeting the additional cost overruns.
However, and this is only one of many contenders; it could a very great deal for Pharmac. Sadly, NZ is well behind many other countries in the drugs it funds. One estimate is that with an additional $400m pa, it could do the job properly.
The pharmaceuticals all come from overseas and this requires a transfer of NZD into foreign currency. Fiat currency can always be printed in NZ, but for the pharmaceuticals to come into NZ someone inthe financial chain has to purchase foreign currency. Just because the expenditure is denominated in the NZ accounts in NZD terms does not change the reality that the transaction requires a purchase of foreign currency. And unlike fiat NZD, the RBNZ cannot create international currencies. The pharmaceuticals are imports which are included within the external current account. That is not the case with the LSAPs
KeithW
keithW,
I understand the technical point, but I think you miss the larger issue here. Wherever the money comes from, Pharmac is insufficiently funded and needs government to inject more money into the system.
My cancer drugs-Keytruda being one of them-are pretty expensive and most Kiwis could not afford them. For me, that would have quite literally been a death sentence. There are many others in just that position and a much larger number whose lives are severely affected by not being able to access drugs which are widely available in many other countries.
Have a brief look at the website The Medicine Gap and you will see what I mean. Governments apportion money in silos-departments-who guard their allocation fiercely, but money is fungible.
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