Philip Lowe on Australia’s response to the pandemic

Philip Lowe, Governor of Reserve Bank of Australia since 2016, in his speech on 24 April 2020, gave an update on the economic and financial condition in Australia in the context of the Covid-19 pandemic.

Lowe predicts that Australia will experience in the first half of 2020 “the biggest contraction in national output and income …witnessed since the 1930s.” During this period, national output will likely fall by around 10%, with unemployment rate at around 10% by the end of June. Prices are expected to fall significantly in the June quarter, helped by fall in oil prices, introduction of free childcare, and the deferral or reduction in some price increases.

The bridge to recovery will be smoother because of the long record of responsible fiscal policy which will help smooth out the income shock and offer protection to those most affected. The strength of the banking system acts as shock absorbers, enabling payment deferrals and concessions in terms. The Reserve Bank’s balance sheet also keeps funding costs low and credit available to businesses and households.

The twin health and economic emergencies will affect the economy for some time to come. Nevertheless, the economy could bounce-back from the September quarter onwards. The GDP growth next year could be 6–7 per cent, after falling 6 per cent this year. Unemployment rate will be above 6 per cent and inflation below 2 per cent over the next couple of years.

The Reserve Bank’s Policy Response

Lowe sums up the RBA’s policy response into five elements:

  1. Reduction in cash rate to 25 basis points with forward guidance that it will not be increased until there is sustainable progress towards full employment and inflation containment.
  2. Targeted yield on 3-year Australian government bonds of 25 basis points, and a preparedness to buy government bonds in whatever quantities needed to achieve that target
  3. Term Funding Facility, providing access to authorised deposit-taking institutions (ADIs) from the Reserve Bank for three years at 25 basis points, with additional funding if ADIs increase lending to business, especially small and medium-sized businesses.
  4. Using daily open market operations to ensure liquidity and using bond purchases to promote smooth functioning of the government securities market.
  5. Modifying the interest rate corridor system so that balances held in Exchange Settlement Accounts at the Reserve Bank earn 10 basis points, rather than zero.

These measures have been effective. Under the Term Funding Facility, around $3 billion of the initial allowance of $90 billion has already been drawn. Availability of this facility has reduced concerns about the future.

Australia has preserved the sanctity of separation of its monetary and fiscal policies, whereby the central bank does not finance the government. Instead the government finances itself in the market. But, its bond purchases do affect the price the government pays to raise debt. Central bank policies also affect the price that the private sector pays to raise its debt.

In doing so, this scheme has supported confidence that Australia’s authorised depository institutions will be able to access the liquidity needed to support their customers. It has also contributed to the low cost of borrowing new funds at fixed interest rates for businesses and households.

The monetary and fiscal policies have worked in tandem to mutually reinforce the outcomes. While the RBA’s package has kept the cost of funds low while ensuring its adequate supply, fiscal policy is supporting jobs and incomes. Businesses have also contributed by adopting more flexible policies with regard to their employees and customers. These, Lowe concludes, is enabling Australia to build a bridge over the crisis to better and faster recovery. Very inspiring speech indeed, and it is not empty bravado, but backed by facts on the strength of the banking system, the Reserve Bank, and a responsible fiscal system.

© G Sreekumar 2021

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