The Reserve Bank has been widely tipped to start “conventional” quantitative easing at tomorrow’s Melbourne Cup meeting, moving on from the yield curve control (YCC) that it pioneered back in March.
Why might they have decided to change tack? To be clear monetary policy could be eased further under either framework. If the RBA wants to stimulate the economy then either new assets purchases or decisions to set the yield curve lower for longer would do the job.
So if they can support the economy under either approach, why (does the press) believe they will switch? I can think of 5 reasons why the Reserve Bank might switch to quantitative easing:
It avoids long term commitments. While pegging 3 year interest rates at a level close to zero doesn’t require a guarantee that the overnight rate be kept at that level for the next 3 years the RBA has effectively tied the two decisions together. While extending the promise to keep interest rates low to, say, 4 years would boost the economy today it might place the RBA in a tricky position further down the road when it might be tempted to raise interest rates in say 2024 even if it means breaking promises it made in 2020.
Low government debt is no longer an issue. One of the core motivates behind yield curve control was the ability to push long term interest rates down, without buying a substantial share of the Australian Treasury market. Heading into the crisis the stock of Commonwealth debt was relatively low. If the RBA had run a QE program in March that was comparable to other countries there was a risk that it would end up buying a large share of the bonds on issue - leaving an insufficient amount for the financial sector use. In the subsequent 6 months however, the Australian Treasury has issued $250 billion in new debt. Low levels of commonwealth debt is no longer a concern!
More flexibility over what assets to buy. While the RBA has stuck to government debt when implementing YCC, QE has historically come in many different flavours with central banks buying mortgages, corporate debt, foriegn assets and even equities. While it is unlikely that the RBA will start buying any of these more exotic assets tomorrow, setting up a QE program today will make it easier to start purchasing other assets (such as US denominated assets to depreciate the exchange rate) at a future meeting.
QE is easier to adjust month by month. While it is unlikely that the RBA will try to use QE to fine tune the economy meeting by meeting, it is much easier to adjust the quantity of bonds being purchased on a monthly basis then it is to adjust YCC. YCC effectively pegs the price of a government bond, and such a peg could be subject to a speculative attack in the event that the market believed that it was going to be changed at the next meeting. The RBA could defend the peg, but it might require more purchases then they would otherwise be comfortable making.
QE can be tied more closely to the state of the economy. Having the ability to vary asset purchases month by month means that the RBA could tie the size of their QE program explicitly to macroeconomic outcomes. If unemployment rises the RBA could automatically buy more, and the reverse should the economy improve. This would provide an additional degree of automatically and stability to monetary policy and would better help guide the economy back to full employment. Making QE state contingent will be a big factor in determining how effective it is at improving the economy.
Either way we will find out at 2.30pm tomorrow when we will have 30 mins to tweet through their decisions before the race that stops the nation!